This scribe recently attended an important seminar organised by the Bangladesh Institute for Professional Development and Bangladesh General Insurance Company Ltd., where a few international participants from similar organisations in India also attended. The seminar's theme was highly relevant in the context of the changing scenarios of the contemporary global financial sector. The collapse of four banks including the latest Republican Bank has been creating ripples in the global financial sector of almost all jurisdictions and questioning the very foundation of its existing governance structure. The seminar was, therefore, well-contextualised.
The governance concerns related to the financial sector and financial institutions are, no doubt, intertwined, interconnected, and overlapped with numerous macro and micro-level aspects of society. Therefore, it is virtually impossible to identify a particular issue related to the governance of the sector which could be identified as the most important one.
Yet, this scribe flagged 'customer confidence' as the most critical element of the financial sector, particularly in the present context. Here, customer confidence refers to the confidence of the society on the financial system.
Financial institutions are necessarily businesses. And these businesses, be that banks or NBFIs or insurance companies or even MFIs, must ensure that their customers and potential customers have trust on them to sustain and thrive defying the challenges.
And it is this 'trust' or 'confidence' for which corporate good governance in the financial sector is of critical importance. This is because customers and/or investors do not only consider the 'promises of benefit/return' made by the financial institutions to them, but also consider how the businesses are run and if they will sustain at all for a longer period or not.
Today's customers/investors are naturally aware (to varying degrees) that the more compliant an institution is, the more it is likely to fulfil those 'promises of benefit' made to them.
Striving for good governance with the intention of boosting customer confidence is, therefore, a 'customer-centric' approach. Indeed, the customer's trust always comes first, particularly in the financial sector.
Corporate good governance is equally important from the 'business sustainability' point of view as well. It is well established that 'good corporate governance' ensured through placing systems, controls, and processes results in long-term sustainability of the companies. This includes, in the words of Secretary General of Indian Insurance Institute Mr. S.N. Satpathy, 'corporate fairness, transparency and accountability.' This scribe would add 'social responsibility' as well. Finally, most financial institutions encounter leakages in their governance structure mainly for the lack of internal control and compliance mechanisms. This can be synonymous with lack of 'self-governance' as well.
Therefore, there is an urgency for developing well developed standards of good governance for the financial institutions during this turbulent period of global economic crisis.
In an increasingly integrated (and digitalised) financial system, risks quickly spill over across different vertical and horizontal jurisdictions of financial institutions, exacerbate through the financial system and have a contagion effect on the real sector. In fact, this cross-over of the risks from the financial to real sector landscapes can only be contained in a well-governed financial sector. And hence the need for a continuously focused monitoring by the regulators of the financial sector.
Any weakness in the governance edifice exposes the financial institutions to operational risk which quickly translate into credit, market, liquidity or reputation risk, or into a combination of all these.
Therefore, those who lead or steer or regulate financial institutions must look beyond the confines of their entity to the impact it has on the world around them.
Here, we must take a synergistic view of the relation between the financial institutions and the society at large including the real economy.
On the one hand, financial institutions need to adhere to a system of governance that fosters ethical practices so that business can thrive and sustain and on the other, the broader society (i.e., the state on behalf of the society) must instil a regulatory regime (policies and regulations) that fosters healthy competition among the financial service providers. This regulatory regime must also set and communicate to the relevant stakeholders the desired and reasonable 'ethical standards' for the financial institutions to adhere to.
Given this backdrop, financial institutions and their regulators across the globe are keen on putting in place systems, controls, and processes to ensure robust governance standards.
The primary objective of corporate governance is to safeguard stakeholders' interests in a sustained manner by ensuring that work is undertaken in a legitimate, responsible, and ethical manner. In the case of banks and other financial institutions, shareholders' interest must not, however, precede depositors' interest.
The Basel Committee on Banking Supervision (BCBS) came up with a set of 13 corporate governance principles. These provide a comprehensive guide for developing suitable corporate governance systems commensurate with the size, complexity, systemic importance, substantiality, and interconnectedness of banks and financial institutions.
The BCBS principle basically puts forward four lines of defence model to protect FIs from governance failures.
The first line comprises the day-to-day operation guidelines to prevent malpractices (e.g., management controls). The second line of defence includes the functions of a Financial Institution that ensures compliance. On top of these the 'internal audit' mechanism constitutes the third line of defence. And finally, supervision by the regulator and external audits are taken to be the fourth line of defence.
In this context, it will be interesting to see how these measures and practices can positively impact the specific FIs (including insurance companies) and how not taking these measures can put our financial system in risk which in term can hurt the macro economy itself. If the regulators were very active in monitoring the activities of the financial institutions, there would have been desired competition among these entities leading to an optimal range of returns on investment by each of them. However, it has been observed from the financial reports of the insurance companies that their returns on investment could vary from 3 per cent to 18 per cent in a single year. Does that mean that there is no competition in the sector?
It has been observed that presence of more competent independent directors who are also well compensated in vital committees like audit, risk management and if possible, the chair's position itself greatly improve customer confidence on the board and as well as the performance of the company.
Greater disclosure and redressal mechanism of complaints of the customers through a digital customer interest protection centre also improve the quality of governance and customer satisfaction. We had put in place a Customer Interest Protection Centre (CIPC) in Bangladesh Bank with a hotline. The complaints from the customers of the banking sector used to be recorded through this hotline incautiously and an Annual Report had me made on the outcomes of this intervention. This Report used to be presented in front of the stakeholders including the customers. All this enhanced the level of customer trust in the sector. It is expected that this practice is still on in Bangladesh Bank even if the size of the customer base may have significantly expanded.
Similarly, a provision of protecting the 'whistle blowers' or the presence of an ombudsman can greatly improve the confidence of the employees in a financial institution who can be motivated for more transparent and ethical operations of day-to-day businesses. It is known for sure one of the public banks in Bangladesh has been practising both innovations with a considerable positive impact on their level of performance. More could be done, if these innovations were replicated in other institutions as well.
The current paper would like to take this opportunity to point towards two governance-related issues/challenges that remain relatively less-emphasised in corporate governance discourses. This lack of attention may be especially true for Bangladesh and other developing countries.
First, is the issue of 'financial literacy'. It can now safely be argued that our financial sector has gone through a dynamic phase of progress over the last 13-14 years owing to the inclusive and digital finance drive of the central bank of the country. Yet, it must also be acknowledged that we have a lot to improve in the field of 'financial literacy'. There is certainly a huge information gap between what is available in the market and the demand side of the customers. For example, there are several green products in the market that can enjoy refinancing facilities, particularly in the MSMEs, housing, and RMGs sectors. There are low-cost long-term loans for the potential green entrepreneurs. The central bank has been providing huge refinancing support to the banks. But the mindset of the bankers remains archaic and may not feel motivated to pass the information to the potential or even existing borrowers. All this calls for massive financial literacy drive which nought to be steered by the financial regulators and top bankers. The boards of the financial institutions are also oblivious to these new products although the future businesses ought to be green and climate-friendly. For example, 80 per cent of the new proposals of energy plants during 2022 were on renewable energies. This only tells us which ways the future energy businesses will move to. However, the financial sector in Bangladesh remains bogged down with the conventional energy businesses without understanding the direction of the future businesses. So is true of digital businesses centring around artificial intelligence, large-scale data management and the surge in smaller enterprises led by women. The corporate leaders are far behind the curve with regard to these businesses of the future. Good corporate governance means creating enabling environment to embrace this future business.
Regardless of the measures we put in place to ensure ethical practices, if our customers remain less-informed about contemporary realities (i.e., new technologies, compliance requirements, etc.), we cannot expect to have a resilient low-risk financial sector in the country.
The cases of frauds related to MFS transactions (where customers give out their PINs to criminals) are testimony to this ignorance or callousness by the victims. Had we been able to properly sensitise the customers about the importance of privacy in financial transactions, the number of such fraud cases could have been much lower.
The issues related to 'financial literacy' may be of more importance for our insurance sector as well, as it is relatively less evolved (than the banking sector) and the customer base remains less aware of the benefits and procedures related to insurance.
It must be noted that the more aware our customers are, the more they will be able to hold the service providers accountable. And that will contribute significantly towards improvement of corporate good governance.
The second challenge is related to introduction of a 'fixed and straight-forward' set of guidelines for ensuring corporate governance.
Realities of the financial sector are ever changing. Introduction of new technologies in the financial system, and demand for new financial products are growing at an unprecedented level. Given this context, it is almost impossible to come up with a guideline that will cover all governance-related challenges a financial sector leader may face.
We should rather adhere to 'learning'. We must welcome what is new. Being too risk-aversive may do more damage than good. Therefore, we are to try new things cautiously and see what works and what does not.
Financial sector leaders and policymakers must ensure that existing compliance standards are maintained. At the same time, they must also remain attentive to the changing realities and emerging challenges. And they must continuously share knowledge and experiences so that everyone may work together in a coherent manner to face newer governance challenges. For that matter, involving younger generation and unserved population in financial literacy could be a prudent move. We have started a school banking programme for the students in Bangladesh Bank which now provides financial services to more than three million young bank account holders. As they become more familiar with the financial operations they not only save more (which is a medium to long-term deposit), they also can dream to become entrepreneurs after finishing their formal education. Some even can start engaging themselves as part-time entrepreneurs while studying as well.
This is where knowledge management becomes pivotal for promoting good governance. In addition, special efforts must be made to improve the quality of human resources through training and knowledge sharing between national, regional and international peers to live up to the contemporary challenges of the financial sector and the real economy. And based on such discourses our governance practices must be revisited and revised/augmented as necessary.
Dr Atiur Rahman is a noted economist and former Governor of Bangladesh Bank. dratiur@gmail.com