Alert October 12, 2010

Basel Committee Issues Final Version of its Corporate Governance Principles and Guidance

The Basel Committee on Banking Supervision (the "Basel Committee") issued revised final Principles and Guidance (the “Guidance”) concerning sound corporate governance of banking organizations (“Banks” and each a “Bank”).  The Guidance updates 2006 Basel Committee guidance on bank corporate governance and reflects modifications that the Basel Committee believes are appropriate in view of the bank and insurance company corporate governance failures that came to light during the financial crisis that began in mid-2007.  The Basel Committee states that the Guidance: (1) is not intended to add a new regulatory layer on top of existing, national statutes; (2) is intended to assist Banks in enhancing their corporate governance framework and to assist Bank supervisors in assessing the quality of their corporate governance framework; (3) should be implemented in a manner that reflects the size, complexity, structure, economic significance to and risk profile of the Bank; and (4) should be applied in a manner consistent with applicable national law. 

The Guidance articulates fourteen corporate governance principles, which can be summarized generally as follows:

  1. The Board has overall responsibility for the Bank, including approving and overseeing implementation of the Bank’s strategy, risk management, corporate governance and corporate values.  The Board should also oversee senior management.
  2. Board members should be and remain qualified.  They should receive training and clearly understand their role in the Bank’s corporate governance.
  3. The Board should define appropriate governance practices for its own work and confirm that such practices are followed and periodically reviewed for possible improvements.
  4. The Board  of a parent holding company is responsible for seeing that there is adequate corporate governance throughout the corporate organization.
  5. Under Board direction, senior management should see that the Bank operates in a manner consistent with the Bank’s business strategy, risk tolerance/appetite and Board policies.
  6. Banks should have an effective internal controls system and risk management function (including a chief risk officer) with sufficient authority, stature, independence, resources and access to the Board.
  7. Risks should be identified and monitored on an ongoing firm-wide and individual entity basis, and should be updated as a Bank engages in new or expanded activities and as the external risk landscape changes.
  8. A Bank should have robust internal communications about risk, both across the organization and through reporting to the Board and senior management.
  9. The Board and senior management should use effectively the work of the external auditors, the internal auditors and other internal control functions.
  10. The Board should actively oversee the compensation system design and operation and monitor the compensation system to see that it operates as intended.
  11. An employee’s compensation should be aligned with prudent risk taking.  Compensation should:  be adjusted for all types of risks; be symmetric with risk outcomes; have payment schedules that are sensitive to time horizons of risks; and have a mix of cash, equity and other compensation that is consistent with risk alignment.
  12. The Board and senior management should know and understand the Bank’s operational structure and the risks it poses.
  13. If a Bank operates through special purpose structures that impede transparency, its Board and senior management should understand the purpose, structure and unique risks of these operations.  They should also try to mitigate these risks.
  14. The governance of the Bank should be adequately transparent to its shareholders, depositors and other stakeholders.

The Guidance concludes with a discussion of the role of supervisors with respect to Bank corporate governance.  Supervisors should make Banks aware of the supervisors’ expectations for sound corporate governance.  Moreover, the Guidance states that supervisors should regularly conduct a comprehensive evaluation of a Bank’s overall corporate governance policies and practices and the Bank’s implementation of those policies and practices.  Furthermore, supervisors should monitor a Bank’s internal and external reports, including reports from internal and external auditors.  Supervisors should require effective and prompt remedial action by a Bank to address material weaknesses in its corporate governance policies and practices.  Finally, supervisors should cooperate with other supervisors in other jurisdictions to supervise a Bank’s corporate governance policies and practices.