Corporate governance for ADI’s

John Laker, Chair of APRA has strongly rebuffed critics of APRA’s draft governance standards in a speech to the Asian Bankers Association Symposium on “Promoting Good Corporate Governance”.

He posed three questions:
• Should corporate governance standards in regulated financial institutions be higher than those for non-financial firms?
• If so, how does a prudential regulator seek to promote those standards?
• Are governance requirements a burden on financial institutions?

He answered the questions as follows:

In its consultative document, Enhancing Corporate Governance for Banking Organisations, the Basel Committee set out the arguments why corporate governance for banking institutions is of greater importance than for other companies, given the crucial financial intermediation role of banks in an economy, the need to safeguard depositors’ funds and their high degree of sensitivity to potential difficulties arising from ineffective corporate governance. The Committee stated that effective corporate governance practices, on both a system-wide and individual bank basis, are essential to achieving and maintaining public trust and confidence in the banking system, which are critical to the proper functioning of the banking sector and economy as a whole.

The Committee concluded, without qualification, that “minimum standards of corporate governance for banks should therefore be more ambitious than for non-financial firms.” (p4). APRA strongly supports this conclusion. Indeed, we believe it also applies to all regulated institutions responsible for safeguarding the financial and physical assets of the community…

APRA’s recent governance proposals have prompted a response from some quarters in Australia that corporate governance is no place for a prudential regulator and should be left to business laws — in our case, the Corporations Act. This view is plainly wrong, and betrays a lack of understanding of the role and history of prudential regulation in this country. The Corporations Act establishes general obligations on board directors and other officers to act with care and diligence and in good faith; inter alia, it also sets out requirements for independence of external auditors. These obligations apply to all incorporated bodies, as much to a small manufacturing concern as to a major financial institution. However, the Corporations Act is silent on the interests of depositors and policyholders. It is silent on a board’s responsibilities for risk management. It is silent on board composition and skills. It is silent on the internal audit function. On its own, the Act provides a starting point for a robust prudential framework for governance of financial institutions, but additional requirements are needed in the interests of APRA’s beneficiaries…

Nor can it be left to the ASX, for one very obvious reason. Of the over 400 institutions APRA regulates in the deposit-taking and insurance industries, only 18 or four per cent are listed companies. Without APRA’s prudential framework, there would be no “ambitious” minimum governance standards, to use the Basel Committee’s words, for 96 per cent of regulated financial institutions in Australia…

A related claim is that APRA’s proposed requirements are an additional burden on that small number of regulated institutions that are listed on the ASX. How could this be if, at first blush, our requirements merely reproduce the “best practice” recommendations of the ASX Corporate Governance Council? The issue is that our requirements, as proposed, would bind on all regulated institutions whereas the Council’s recommendations apply only on an “if not, why not” basis. They are guidelines for listed companies and if a company considers that a recommendation is inappropriate to its particular circumstances, it has the flexibility not to adopt it, provided shareholders are given an explanation.

APRA’s final governance standards are due for release in early 2006.

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