Arab Banking: Market Discipline, Governance and Transparency – Part V

Wafik Grais, 05 Mar 2015

Having reviewed Arab governments’ approaches to micro- and macro-prudential banking regulations, Part V turns to the challenges faced in promoting market discipline, ensuring good bank governance and furthering transparency.

 

Market disciple is the third pillar of Basel II. However, the region’s financial institutional arrangements do not provide adequate means or incentives for market players to monitor bank performance. Pillar 3 relies on the assumption that market discipline imposes strong incentives for banks to conduct their business in a safe, sound, and efficient manner. It complements the minimum capital requirements (Pillar 1) and the supervisory review process (Pillar 2). Its aim is to encourage market discipline by developing a set of disclosure requirements that will allow market participants to assess a bank’s capital, risk exposure, and risk assessment processes. Despite improvements in recent years, disclosure of banks in Arab countries falls short of requirements for an effective role of market discipline.

 

Incentives for all stakeholders to monitor the banks are weak due to strong implicit deposit insurance, essentially a blank check, or the absence of bank failures and credible bank resolution arrangements that would lead to wiping out shareholders and subordinated creditors,   (Rocha et al. 2011). Furthermore, these guarantees are potentially costly and have created expectations that bank failures will not be tolerated. The public expects regulators to step in and resolve any systemic or bank-specific crisis. These expectations create incentive problems, weaken market discipline, and place additional burden on supervision.

 

Most banks are required to disclose financial statements at least annually, and usually more often. Some countries require all banking institutions to take the form of joint stock companies and to be listed on the domestic stock exchange, thereby requiring them to disclose financial statements that are compliant with International Financial Reporting Standards (IFRS).

 

However, there appear to be inconsistent disclosures, particularly in the area of consolidated financial reporting, as well as differences in the valuation of common exposures. Nonfinancial disclosure is less developed than financial disclosure, hindering the assessment of banks’ risk governance. Most banks are audited annually. In a number of countries, the audit business is concentrated, and some firms have long-standing ties to the banking sector. External audit staff with skills in banking and banking-related activities are lacking in some countries, requiring further development.

 

Regulators have been active in the area of corporate governance. For example, the Saudi Arabia Monetary Agency (SAMA) has issued principles for corporate governance covering various aspects of board composition and operations, including qualifications of board members and committees. Similarly, the Central Bank of Egypt (CBE) has issued corporate governance rules focused on (a) a clear definition of the responsibilities and obligations of the members of the board of directors, besides emphasizing that the senior management is accountable to the board; (b) the roles of the board committees and their formation; (c) the supervisory role of the board on risk management and internal control systems; (d) the formulation of effective policies for salaries and remunerations and for the management of conflicts of interest; and (e) the principle of transparency and disclosure of important financial and nonfinancial information.

 

Many boards across the Arab world have reviewed and formalized their structures. Audit and risk management committees are generally in place or being set up. Nomination and compensation committees are less common. Awareness of the need to link remuneration to institutional performance is increasing. The practice of a majority of independent directors and nonexecutive members sitting on the audit committee is not yet widespread.

 

With governance, transparency and discipline making strides, it is time to see just how well the Arab banking sector is performing.  The final two installments in this seven-part series examine banking financial and economic performance across the region.

 

Read Part I, Part II, Part III, Part IV, Part VI, Part VII

 

 


Wafik Grais is an International Senior Adviser specializing in Islamic finance, financial regulation, investment financing, private equity management, and corporate governance with expertise in SMEs and green growth financing. He was co-founder and chairman of Viveris Mashrek, a Cairo-based, financial advisory services company specialized in private equity investments in SMEs, licensed by Egypt's Financial Supervisory Authority. He spent 28 years in international finance notably with the World Bank in Washington DC where he held several senior positions both in operations and at corporate levels. He holds a Ph.D. in Economics.

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