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SAGIT – CG framework saves the day

By Taurayi Mushambi

THE demise of distressed financial institutions such as ENG, Intermarket and Trust was due to mismatch between assets and liabilities where the latter were greater than the former such th

at creditor maturities could not be met.

The symptom common with these institutions was failure to meet maturities. The question is: Did we need to wait for these symptoms or could all this have been prevented?

The solution to preventing future collapse of these custodians of public funds is a regulatory corporate governance framework which should be mandatory. Sadly, it was only after the firms had closed that the regulatory authorities finally decided to come up with a corporate governance guideline (No 01-2004/BSD).

Corporate governance (CG) refers to the processes and structures used to direct and manage the business and affairs of an institution with the objective of ensuring its safety and soundness and enhancing shareholder value.

CG defines the division of power and establishes mechanisms for achieving accountability between the board of directors, management and shareholders.

The duty of management is to manage the day-to-day operations of the firm. Management is accountable to the board of directors (BOD) whose main duties include defining the strategic plans of the firm, monitoring of operational performance and management and most critical to CG, the determination of policy and processes to ensure effective risk management and internal control. In turn the BOD is answerable to the owners of the business, the shareholders.

What happens when the majority shareholders are also the management of the firm and some of them are also on the board of directors as was the case at some of the institutions where top management was also on the boards of almost every subsidiary? The effect is the loss of independence in management and ownership with management doing everything in their personal interests without due regard to the effect of their selfish behaviour on various stakeholders and minority shareholders.

One of the requirements of the guideline with regard to the separation of ownership and management is that no shareholder with 10% or more shareholding in a banking institution or bank holding company shall form part of the management of the institution. Also no shareholder with 10% or more shall be appointed as chairperson or deputy chairperson of the BOD of an institution.

This goes a long way in preventing prejudice of depositors whose funds are expropriated into personal coffers of management who do not have anyone to answer to by virtue of them being also the owners of the firm in addition to being the management.

Each banking institution is now required to have a minimum of five directors with the majority being non-executive so as to render independence to the BOD from the executives who are involved in the day-to-day management.

This will help mitigate any possible conflict of interest between the policy-making process and day-to-day management. The majority non-executive directors are also important in standing for the interests of minority shareholders and other stakeholders in the decision-making process.

The other duty imposed on the BOD as a CG requirement is to ensure that the banking institution they are heading has adequate systems to identify, measure, monitor and manage key risks facing the banking institution.

The nature of business of banking institutions whereby they use depositors’ funds to make their profits whilst at the same time being under legal obligation to repay funds on the depositors’ demand exposes the financial institutions to a wide range of risks peculiar to them such as market risk, credit risk, continuity risk etc.

If these risks are poorly identified and managed, they expose the institutions to potential financial distress. Market discipline in the form of prudent trading plays a very important role in promoting financial system stability and in encouraging the maintenance of sound corporate governance and risk management practices. An Asset and Liability Committee is also a CG requirement whose duty is to determine the appropriate mix of assets and liabilities after taking into consideration expected future interest rate movements, liquidity constraints, foreign exchange exposure and capital adequacy.

Market indiscipline in the form of over trading resulted in the now defunct institutions having liabilities in excess of assets. The Reserve Bank of Zimbabwe’s policy whereby banks are penalised for unbalanced positions is most welcome so as to encourage banks and other corporates to pay attention to risk management and prudent asset-liability mixes.

High quality financial disclosure is an essential complement to good corporate governance since it puts management in the spotlight of varying stakeholders and the public. Thus, as a means of strengthening the accountability of directors and senior management, the RBZ should implement mandatory financial disclosure requirements for corporates and banking institutions. In addition, the RBZ should step up on and off-site surveillance to keep a constant watch on banking activities and take action before corrupt and creative accounting activities get out of hand.

* Information contained herein has been derived from sources believed to be reliable but is not guaranteed as to its accuracy and does not purport to be a complete analysis of the security, company or industry involved.

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