Corporate Governance in Banking and Investor Protection

The financial crisis of 2007–2008 fueled the idea that corporate governance in the financial sector urgently needed reform. The perception that poor corporate governance was a primary cause of the breakdown of the financial markets prompted extensive regulatory actions around the world. However, whether and how regulating banks’ corporate governance results in a better-functioning economy is a subject of ongoing debate. In this chapter we summarize the theoretical arguments for regulation and survey the empirical evidence on the role of corporate governance in the financial industry. The focus of our review is the post-crisis reform of banks’ corporate governance, as seen from a historical perspective. The discussion will be structured around the main corporate governance mechanisms, namely (i) internal governance mechanisms (i.e., managerial compensation, board monitoring, and internal control systems), (ii) market discipline (i.e., the roles of competition, the takeover market, and the shareholder activism), and (iii) regulatory intervention (i.e., capital requirements and regulatory supervision). Although a large part of the available evidence uses US data, our analysis also reviews corporate governance developments in important economies around the globe. We conclude by pointing out the limitations of empirical research in informing the debate on regulatory activity.

Banking regulation, including corporate governance in banking, needs to strike a balance between the costs and benefits of regulatory intervention. This chapter aims at extending the theoretical base for the cost-benefit trade-off in bank governance regulation by providing a law and economics framework of how banks interact with listed non-financial firms in view of the modern financial intermediation literature. To this end, the chapter first takes up a qualitative analysis of the tension underlying governance regulation of banks by referring to the post-crisis regulatory measures in the European Union as an example. Subsequently, the chapter uses agency theory to investigate banks’ roles for corporate governance of listed non-financial firms. Three qualitative case studies are presented, revealing that banks’ influence over non-financial firms appears to be more multidimensional than commonly considered in the literature. Specifically, it is shown that bank monitoring and control can present opportunities as well as challenges for listed non-financial firms by affecting their governance arrangements with implications ranging from day-to-day business operations to fundamental capital market transactions in addition to the distress context. The chapter also discusses the implications of differences in ownership structures and identifies possibilities of bank influence both in concentrated and dispersed ownership contexts. Overall, the findings of this chapter contribute to the debate on the effectiveness of corporate governance in banking by bringing in a largely neglected dimension into the picture and establishing a theoretical basis for an improved balancing act in policymaking.

The financial crisis revealed the lack of effectiveness of corporate governance (CG) principles in the financial services sector. During recent years, several aspects of corporate governance have been subject to hard law regulation in the European Union for the benefit of shareholders, such as remuneration (Directive 2010/76/EU), shareholder rights (Directive 2007/36/EC) and transparency/nonfinancial information disclosure (Directive 2014/95/EU). However, some questions remain unanswered. Are governance structures the same in financial and non-financial firms? Are the same CG recommendations applicable to both sectors? Has the crisis changed the way financial and non-financial firms are governed? Without a deep knowledge of these issues, governance policies cannot be fully developed. This paper considers the differences in CG across Europe, analysing 33 variables that measure policies related to corporate governance, including the areas of board structure and functioning, committees, compensation policy, anti-takeover devices, shareholder rights and Corporate Social Responsibility. Our analysis focuses on a sample of 206 enterprises that belong to the main stock market indexes of Spain (IBEX 35), France (DAX), Germany (CAC-40) and the United Kingdom (FTSE-100), dividing the sample into financial and non-financial firms and considering the pre- and postcrisis period. The results show sector-based differences in CG in six variables in 2007 and in eight variables in 2013 for the full sample. Therefore, financial firms were not worse governed than non-financial firms before the crisis, and since the crisis financial firms have also been similarly governed to non-financial firms. The crisis has affected almost half of the CG variables analysed in financial firms. There were also country-based differences in CG in 19 variables in financial firms. These differences between countries show the difficulty in developing common governance recommendations for all European countries without considering their own specific characteristics.

This chapter analyses IT governance disclosure for a sample of 12 EU banks (from Italy, Germany, France and Spain) to observe if, how and where banks report on their IT governance issues and to verify if after the crises, banks have started to pay more attention to IT governance. Since IT governance (like other aspects of banking business) can be influenced by the regulatory environment we examine whether any differences in Supervisors’ attitude to IT issues induce differences in IT governance across countries. Regarding IT governance transparency, as a key mechanism of corporate governance, we: i) outline an original IT governance framework; ii) perform a content analysis on banks public disclosure and a selected number of Supervisors’ official documents (2008–2015) to build up IT governance indices; and iii) run a multidimensional analysis to detect causal relationships between variables.

This study compares the board features of major listed bank and non-financial firms in Europe. We find that at the industry-specific level the structure of bank board’s is similar to that of non-financial firms, although banks tend to have more meetings and committees. Second, when we consider country-specific board diversity, bank boards are similar across countries apart from in Spain where the bank boards have a higher presence of older directors, a lower number of independents and foreigners, and more meetings. Finally, when we look at domestic-specific board diversity differences we find no statistically significant differences. All in all there is not much difference between bank and non-financial boards.

This article analyzes how creditor rights influence the loan supply reaction of banks to monetary policy through the bank lending channel. Additionally, we test whether the influence of creditor rights on lending is different before and after the crisis. Using a sample of 1096 listed banks from 36 countries between 2003 and 2015, we find that creditor rights do not directly influence loan supply, neither before nor after the crisis, but they play an important role during monetary shocks. In this regard, the bank lending channel of monetary policy is less effective in countries with stronger creditor rights.

This paper documents the presence on average of cost economies of scope in the European banking industry, that is, banks minimize total costs, given a certain level of outputs, producing a differentiated mix of outputs. Our results are particularly important in the light of the 2014 structural reform proposal on the EU banking industry which aims to separate the traditional commercial banking from investment activity. The loss of efficiency for banks might have consequences for customers who could suffer an increase in the costs of financial services to try to compensate banks for their loss of efficiency. Bank regulations would be myopic if they focus on investor protections whilst neglecting bank efficiency.

This chapter aims to examine recent regulatory reform on corporate governance of financial conglomerates in Indonesia. Over the past few decades, financial conglomerates have rapidly emerged and become the prevalent feature of Indonesian financial markets. These conglomerates are complex. They give rise to intricate corporate governance issues due to their complexities. To minimise the issues and to endorse good corporate governance practices of financial conglomerates, the Indonesian Financial Service Authority enacted a regulation on the implementation of integrated corporate governance for financial conglomerates in November 2014. This is the first regulation that specifically addresses financial conglomerate in its entirety as a group in Indonesia. It sets out minimum requirements to be followed by financial conglomerate in establishing its group-wide corporate governance arrangements. Dissimilar to many other countries that adopted the financial holding company concept, this regulation requires a financial conglomerate to appoint the lead entity, which is either the parent company or an appointed sister company, to be held responsible for implementing integrated corporate governance of the financial conglomerate in its entirety as a group. This chapter critically evaluates the regulatory requirements on corporate governance of financial conglomerate, especially related to the lead entity, in this regulation. It finds that many requirements specified in this regulation conflict with the requirement stipulated in other prevailing laws. These conflicting regulatory requirements might raise legal issues for the parties within the financial conglomerate. Furthermore, this chapter argues that this new regulation has not fully addressed the corporate governance issues in financial conglomerates. Thus, we suggest further legal reform to enhance the regulation and to address the legal issues and gaps by enacting a particular law for financial conglomerates.

This study investigates the influence of background diversity of bank board members on performance and risk. Using data from Indonesian banks from 2001 to 2011 covering 4200 individual year observations and 21 ethnic groups, we estimate the degree of diversity by considering various aspects (gender, citizenship, age, experience, tenure, ethnicity, nationality, education level and type) and find significant impacts on bank performance. On the whole, diversity is in general positively associated with performance except when it relates to ethnicity. It not only reduces performance per se but also increases risk. Female presence and professional diversity reduce risk but nationality and ethnicity diversities are associated with higher risk. Education diversity generally leads to higher income volatility and leverage risk. Our results are generally robust to various alternative performance measures, including risk adjusted returns, and estimation methods.

This paper uses panel data estimation under the assumptions of the agency theory of insider trading to identify the factors enhancing bank insider trading. We conclude that the more entrenched the directors, the less prestigious the bank, the bigger the firm and the lower the charter values for high levels of ownership, the higher the intensity of insider trading activity. Thus, the emerging picture is of a scenario where insider trading activity is triggered by the absence of efficient control mechanisms, either external (regulators control the level of bank capitalization but it is not easy for them to also control other opportunistic behaviors) or internal (shareholders fail to control managers when managers’ stakes are very low or very high).

The chapter presents the first in-depth descriptive analysis of the Spanish Saving Banks’ boards in terms of size, independence, and quality (knowledge, experience and diversity). We build an original handmade database with the biographical profile of 1525 different directors for the entire population of Spanish savings banks during the period of 2004–2010. Our results show that on average, their board was larger with less knowledge in business and less professional experience in banking but more gender diversity than the private banks analyzed in other studies. These board characteristics barely changed during the period of crisis. We also find that 52% of board members are designated by governments or affiliated with political parties. This figure seems to confirm that although the Spanish savings banks had the status of private entities, the real fact is that they were primarily controlled by politicians. Finally, we show several important differences in the board composition, depending on the savings banks’ financial characteristics.

The privatization and modernization process of the Italian banking system, started in the 1990s, was helped also by the setting up of the Banking Foundations. Indeed, they initially supported Italian banks in the process of consolidation and more recently in the process of recapitalisation, as a consequent need of the crisis. The role played by the foundations in banks’ ownership therefore has always been crucial. Accordingly, they exerted (and still exert) a profound impact on banks’ governance and performance and ultimately on the financial market.

This chapter aims at analysing the trend of the foundations’ share in the capital of the Italian banks, also considering the evolution of the regulatory framework. Our principal goal is to highlight whether their shareholding contributes to the improvement of the stability, governance and profitability of the Italian banks.

The consequences of the global financial crisis of 2007 emphasised the centrality of the banking system to not only economic sustainability, but also the contributions of a robust corporate governance mechanism to the establishment of an efficient banking system. This development provoked a reaction by policy makers across varieties of capitalism including Nigeria. As Africa’s largest economy, Nigeria embarked on a recapitalisation and consolidation exercise in its banking industry following reported widespread structural and operational deficiencies. Despite this intervention, the sector continues to experience a variety of challenges, much of which relates to weaknesses in its poor corporate governance. Whereas the extant literature has examined these problems, this chapter seeks to broaden the literature by exploring corporate governance in the Nigerian banking system from a bounded rationality concept perspective. In doing this, this chapter undertakes a review of corporate governance in the Nigerian banking system, examines the rationality concerns influencing corporate governance practices amongst Nigerian banks, and shows that attempts at addressing corporate governance issues must acknowledge that corporate governance is an information-based mechanism.

The performance of Microfinance Institutions (MFIs) in Ghana has not, to say the least, created the much-touted messianic role it was meant to play. The scale of the malfeasance in this sector in the last 5 years has been quite steep. Loose regulations, massive failure of governance, both within the sector itself and at the level of the regulators and supervisors, poor supervision, inadequate enforcement, perverse incentives, and other practices bordering on sheer criminality have constituted the main problems slashing away the gains of this sector. What was supposed to help reduce poverty among the poor in society is fleecing them from the little that they lay claim to. Some MFIs have now fraudulently folded up after collecting huge deposits from customers, others, meanwhile, have diverted their funds into unrelated activities with some directors facing legal action from aggrieved customers. The chapter examines the drawbacks within the MFI sector in particular and the financial sector in general. It also presents the gamut of issues at play and the doggedness of the central bank to put the sector on a sound footing.

In the investment context, the fiduciary duties are traditionally interpreted as ensuring the highest return on investment with the lowest possible risk for the beneficiaries. However, in the past two decades it became visible, that many beneficiaries of mutual funds demonstrated that they put a certain value on investment outcomes other than financial performance (those non-financial impacts include mainly environmental and social outcomes). This behaviour challenges canonically defined fiduciary duties for investments in instances when meeting the non-financial goals correlates negatively with the return. Consequently, it calls for the reinterpretation of the fiduciary duties of mutual funds and for finding appropriate tools for managing such extended obligations. In this chapter, we aim at building a rationale for an individual investor’s extended utility function that depends on return, risk and—additionally—non-financial characteristics of the investment. We also aim at establishing a stronger link between institutional and individual investment decisions through identifying the best practices adopted by mutual funds with respect to incorporating environmental, social and governance criteria in their investment decisions. In this way we contribute to improving fiduciary duties fulfilment in the modern pooled investment sector.