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There is no doubt that the governance concerns in the financial sector and financial institutions are intertwined, interconnected, and overlapped with numerous macro- and micro-level aspects of society. That is why it is almost impossible to identify a particular issue related to governance in this sector, which could be identified as the most important one.
Customer confidence is the most critical element of the financial sector, particularly in the present context. Here, customer confidence refers to the confidence of society in the financial system.
Financial institutions are necessarily businesses. These businesses, be that banks or NBFIs or insurance companies or even MFIs, must ensure that their customers and potential customers have trust in them to sustain and thrive defying the challenges.
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 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, customers’ 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 the long-term sustainability of companies. This includes, in the words of Secretary General of Indian Insurance Institute SN Satpathy, corporate fairness, transparency, and accountability. I would add social responsibility as well.
Finally, most financial institutions encounter leakages in their governance structure mainly due to the lack of internal control and compliance mechanisms. This can be synonymous with the lack of “self-governance” as well. Therefore, there is an urgency to develop well-developed standards of good governance for 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. That creates the need for continuously focused monitoring by the regulators of the financial sector.
Any weakness in the governance edifice exposes the financial institutions to operational risks that quickly translate into credit, market, liquidity or reputation risk, or 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 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 the 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 financial service providers. This regulatory regime must also set and communicate to the relevant stakeholders the desired and reasonable “ethical standards” for financial institutions to adhere to.
Given this backdrop, financial institutions and their regulators across the globe are keen to put 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 against 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 ensure compliance. On top of these, the “internal audit” mechanism constitutes the third line of defence. Finally, supervision by the regulator and external audits are 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 at risk, which, in turn, can hurt the macroeconomy 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% to 18% in a single year. Does that mean there is no competition in the sector?
It has been observed that the presence of more competent independent directors, who are also well-compensated in vital committees like audit and risk management, and if possible, the chair’s position itself greatly improve customer confidence in the board as well as the performance of the company. Greater disclosure and redressal mechanism of complaints of customers through a digital customer interest protection centre also improve the quality of governance and customer satisfaction.
We have put in place a Customer Interest Protection Centre (CIPC) at the central bank of Bangladesh with a hotline. The complaints from customers in the banking sector used to be recorded through this hotline incautiously, and an annual report had to be made on the outcomes of this intervention. The report used to be presented in front of the stakeholders, including customers. All this enhanced the level of customer trust in the sector. I hope this practice is still on at the Bangladesh Bank even if the size of the customer base may have been significantly expanded.
Similarly, a provision to protect “whistleblowers” or the presence of an ombudsman can greatly improve the confidence of the employees in a financial institution. The employees can then be motivated for more transparent and ethical operations of the day-to-day business. I know for sure one of the public banks in Bangladesh is practicing 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.
I 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. 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 customers. For example, there are several green products in the market that can enjoy refinancing facilities, particularly in the MSME, housing, and RMG sectors. There are low-cost long-term loans for potential green entrepreneurs. The central bank is providing huge refinancing support for banks. But the mindset of bankers remains archaic, and they may not feel motivated to pass the information to the potential or even existing borrowers.
All this calls for a massive financial literacy drive, which ought to be steered by the financial regulators and top bankers. The boards of financial institutions are also oblivious to these new products, although future businesses ought to be green and climate-friendly. For example, 80% of the new proposals for energy plants in 2022 were on renewable energies. This only tells us the way future energy businesses will move.
However, the financial sector in Bangladesh remains bogged down with conventional energy businesses without understanding the direction of future businesses. So is true of digital businesses centring 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 an enabling environment to embrace future businesses.
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 fraud related to MFS transactions (where customers give out their PINs to criminals) are a testimony to this ignorance or callousness on the part of 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 also be of more importance for our insurance sector 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 service providers accountable. That will contribute significantly to the enhancement of good corporate governance.
The second challenge that I would like to point out is related to the introduction of a fixed and straightforward set of guidelines for ensuring corporate governance. The realities of the financial sector are everchanging. The introduction of new technologies in the financial system and the 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 a learning-by-doing approach. We must welcome what is new. Being too risk-averse may do more damage than good. Therefore, we are to try new things cautiously and see what works and what does not.
The 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. 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 the younger generation and the unserved population in financial literacy could be a prudent move. We have started a school banking programme for students at the Bangladesh Bank, which now provides financial services for more than three million young bank account holders. As they become more familiar with financial operations, they not only save more (which is a medium to long-term deposit) but also dream of becoming entrepreneurs after finishing their formal education. Some even start engaging themselves as part-time entrepreneurs while studying as well.
This is where knowledge management becomes pivotal for promoting good governance. Documentation, research, and dialogues such as this one must be regular. 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 in the financial sector and the real economy. Based on such discourses, our governance practices must be revisited and revised/augmented as necessary.
The writer is an Emeritus Professor of Dhaka University and former governor of Bangladesh Bank
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