Focus 2 Guidance For Directors of Banks

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2 Focus
Guidance for
the Directors
of Banks
Jonathan Charkham CBE
Global
Corporate
Governance
Forum
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A B O U T T H E AU T H O R
Jonathan Charkham CBE was educated at St Paul’s school and Jesus College
Cambridge and was called to the Bar. His career spans the manufacturing indus-
try, the Civil Service, and The Bank of England, where his final appointment was
Adviser to the Governor. He set up the Public Appointments Unit in Whitehall and
was the founding director of PRO-NED (Promotion of Non-Executive Directors),
which was established following the secondary banking crisis in the United
Kingdom. A member of the Private Sector Advisory Group of the Global Corporate
Governance Forum, he is a visiting professor at the Cass Business School of City
University, London. He has chaired the audit committees of GUS Plc and Mizuha
International Plc.
Jonathan Charkham has also served on advisory bodies at home and abroad,
including the UK’s Committee on the Financial Aspects of Corporate Governance,
chaired by Sir Adrian Cadbury, which developed the first code of best practice,
and the Vice President’s Council on Competitiveness in the United States.
He is the author of Keeping Good Company, a comparative study of the United

Kingdom, United States, France, Germany, and Japan (Oxford University Press
1994), and co-author (with Anne Simpson) of Fair Shares, which deals with the
role of shareholders in corporate governance (Oxford University Press 1999).
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Guidance for the Directors of Banks
Jonathan Charkham CBE
Global Corporate Governance Forum

Focus 2
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ii Guidance for the Directors of Banks

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C O N T E N TS
Acknowledgements.............................................................................................iv
Foreword, by Luigi Passamonti ............................................................................v
A Note from the Author ......................................................................................vii
1. Terminology .....................................................................................................1
2. Corporate Governance ....................................................................................7
3. The Formal Structure of the Company.............................................................9
4. The Structure and Composition of the Board ................................................13
5. Responsibilities of the Boards of Directors of Banks......................................15
6. Committees of the Board ..............................................................................27
ANNEXES
Annex 1. Operational Risks................................................................................39

Annex 2. Fraud..................................................................................................40
Annex 3. Money Laundering..............................................................................45
Annex 4. Insurance............................................................................................48
Annex 5. Accounting and Auditing Standards....................................................50
Annex 6. An Ethics Statement ...........................................................................51

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AC K N OW L E D G E M E N TS
The Global Corporate Governance Forum would like to thank Mike Lubrano, Head
of the Corporate Governance Unit at the International Finance Corporation (IFC),
for detailed comments upon an earlier draft of this material, which was used by
IFC in training programs for its director nominees. Alex Shakow, World Bank con-
sultant, also provided helpful input.
This Focus has been published as part of a series of practical guides to corporate
governance reform. We welcome comments, which should be forwarded to Alyssa
Machold (amachold@worldbank.org), Project Officer, Global Corporate
Governance Forum.
iv Guidance for the Directors of Banks

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FOREWORD
by Luigi Passamonti
“Good governance is essential for the long-term survival and success [of an
institution] and depends greatly on the skills, experience and knowledge of its
directors.” These few words best capture Jonathan Charkham’s guidance to
directors of banks and other financial institutions.
Banking is becoming so complex that its risks cannot be monitored only by bank
supervisors. And bank regulation cannot try to respond to every single financial
innovation. The safety and soundness of banking requires the upfront involvement
of shareholders and their representatives on the bank boards. As Alan Greenspan
once said, “We need to adopt policies that promote private counterparty supervi-
sion as the first line of defense for a safe and sound banking system.”
This document brings home the point that membership of a board of directors of
a financial institution is not a matter of personal prestige; it carries a significant
burden of personal responsibilities.
Bank directors are the guardians of financial stability, which is one of the most
precious public goods. Bank directors have to ensure that the bank strategy as
conceived and executed by management has an appropriate risk-reward profile;
that financial data accurately represent the bank’s condition; that risk mitigation
measures are adequate to protect depositors’ money and shareholders’ funds:
in sum, that management does its job without incurring excessive risk.
In discharging their oversight responsibilities, bank directors often find it essential

to work with bank supervisors in an alliance to protect financial stability. The
guidance contained in this document about the functions of board subcommittees
is precious to outline the architecture and content of this emerging cooperation
between boards and supervisory authorities.
In developing and transition countries, there cannot be sustainable economic

growth without substantial financial deepening. That means an increased
accumulation of financial savings, making higher corporate leverage possible.
Guidance for the Directors of Banks v

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This is a delicate balancing act: to maintain trust in the financial system stability
while increasing its overall risk exposure. Bank directors and boards play a vital
role in this endeavor. No bank supervisor can match the operational insights and
prompt action capability of a responsible bank board.
It will be a long haul effort to strengthen bank governance but, today, Jonathan
Charkham gives us a very useful starting point.
Luigi Passamonti
Senior Advisor
Office of the Financial Sector Vice President
The World Bank
vi Guidance for the Directors of Banks

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A N OT E F RO M T H E AU T H O R
This manual, for present and prospective directors of noncomplex banks, is intend-
ed to provide a guide to emerging international best practice. It is designed to help
boards of directors in a practical way attain and maintain a high standard of internal
governance. A directorship of a complex bank, especially a large one, implies a further
dimension; even so the basic considera-
tions set out in this manual still apply.
This manual is designed to help
This paper supplements a country’s
boards of directors in a practical laws, rules and other local guidance.
Together their aim is to set banks and
way attain and maintain a high financial institutions on the path towards
enduring prosperity. This is a matter of
standard of internal governance. great importance to all—depositors,
employees, customers, shareholders, the
supervising authority, and the country.
Good governance is essential for long term survival and success, so directors
have a continuing obligation to ensure that not only do they themselves under-
stand and practice it, but that managers in their organization are properly trained
in its principles and practical application.
This paper provides an overview. Directors in all countries are advised to familiarize
themselves with the scope of the relevant legislation, noting that they may be person-
ally liable for breaches of certain provisions. There will be in existence more detailed
guidance on the subject matter of every section of this manual. The intention of the
manual is to ensure that the underlying principles are not swamped by the detail and
to give directors a fundamental understanding of their tasks and the context.
The good governance of any commercial enterprise depends greatly on the skills,
experience and knowledge of its directors. Banks and other financial institutions
require in addition that the directors keep abreast of relevant developments sys-
temic, regulatory, technical and financial (including accounting). It is therefore
essential that individual directors see this as a personal responsibility and that the
board ensures they receive the advice and training they need.
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The guidance was drafted to fit unitary boards and it would need to be adapted to
fit a two-tier system in which the management and supervisory functions are for-
mally separated. Even then the underlying parcel of functions remains the same
though their discharge is different.
Throughout the paper the male gender is used as a matter of linguistic conven-
ience. It is understood of course that everything applies equally to women.
Jonathan Charkham
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1 . T E R M I N O LO G Y
There is a family of terms in descending order from the general to the particular to
describe the direction in which the directors and shareholders wish the bank to
take. Together they describe the framework within which plans are laid and deci-
sions taken about priorities for action for the short, medium and long terms.
Aims—Of these terms, Aims are the broadest and most general. They are
sometimes described as Purposes. Some banks now publish a Mission
Statement. Whatever term is used, the intention is to be explicit about the main
purpose for which the bank exists. Aims are not quantified. How much detail to
include is a matter of judgement.
Strategy —Strategy is the design of longer-term policies to pursue the bank’s

aims. These policies may relate to products and services, acquisitions versus
organic growth, markets, and resources—especially capital and people. Strategy
will reflect priorities in the deployment of the bank’s limited resources. It defines
where the organization wants to go to fulfil its purpose and achieve its aims.
Business plans —Business plans are the blueprints for action for all parts of the
business (and at various levels) to map out the way its strategy is to be attained.
Wherever possible they will include objectives, time constrained and quantified,
although not necessarily in terms of money.
All business plans must be firm but flexible because all businesses face uncertainty
and plans have to be adapted from time to time. The virtue of having them is to
impart a clear sense of direction and to secure the commitment of those called
upon to formulate and achieve them. Many will often link with the budgeting
process (for example a bank could budget for a partial increase in its deposit base).
Plans also help to define the linkages between various aspects of the business. In
banks for instance there is an absolute need to link expansion with capital adequacy.
Managing director —Various titles have been given to the person or persons
in charge of the bank’s executive management such as chief general manager,
general manager, and managing director (there may be more than one, with equal
status). Recently the term chief executive or chief executive officer (CEO) has
come into more common use, but only if power has been concentrated in the
hands of a single individual.
Guidance for the Directors of Banks 1

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Chairman —Strictly speaking, the chairman is chairman of the board, not of the
company, and has duties as chairman relating mainly to the board itself. If he is
also CEO or managing director, he has in effect dual responsibilities.
Corporate governance —Corporate governance is the system by which banks

are directed and controlled in pursuit of their aims, and by which they relate to
their sources of capital.
Risk management —Risk management is the systematic process for identifying

the risks the business faces; evaluating them according to the likelihood of their
occurring and the damage that could ensue; deciding where to bear, avoid, con-
trol, or insure against them (or any combination of these four); allocating responsi-
bility for dealing with them; ensuring that the process actually works; and reporting
material problems as quickly as possible to the right level.
Fidicuary principles —Directors of the bank must always act in its interests
even in the face of a competing obligation. They must act in good faith. It would
be a breach of faith to be disloyal to it (for instance by imparting its confidential or
secret information), or to put one’s personal interests (or those of family or friends)
before its interests.
Conflicts of interest can arise in many ways and directors should always be on
their guard. When in doubt they MUST disclose the matter formally to colleagues.
Failure to disclose a material conflict of interest normally leads to resignation. In
many cases the circumstances will require their absence from deliberations in
which they are conflicted. One particular situation may arise and catch them
unawares—where they hold directorships of more than one company within the
banking group. They should be aware that their duty to more than one company
might mean that they have different fiduciary responsibilities in their various roles.
These principles mean that there is no such thing as a representative director,

even when a particular group of shareholders have the right of appointment. Once
appointed, a director is bound to act in the bank’s interests, that is to say in the
interest of all the shareholders. He may not report to his appointers matters that
the board deems confidential without its permission. Directors owe their duty to
the bank and are answerable to the shareholders for the way they discharge it.
2 Guidance for the Directors of Banks

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Connected parties —The issue of connected parties may be important in many

contexts, especially the concentration of risk. It arises where parties with whom
the bank is doing business are technically separate entities, but where:
• One party has direct or indirect control of the other party, or
• The parties are subject to common control from the same source, or
• One party has influence over the financial and operating policies of the other
party to an extent that the other party might be inhibited from pursuing at all
times its own separate interests, or
• The parties, in entering a transaction, are subject to influence from the same
source to such an extent that one of the parties to the transaction has subordi-
nated its own separate interests.
Related parties —The context is different and mainly affects the terms and
conditions on which business is conducted. The danger is that improper preferential
treatment may lead to a weakening of normal disciplines in such matters as
granting facilities, the terms, and the subsequent monitoring of accounts. Parties
are related if they are:
• Members of the bank’s board of directors, its external auditors, advisers, a
senior manager or one of his deputies and equivalent.
• Relatives of the above or where there is a vested interest between the
two parties.
• Any natural person or entity that directly or indirectly owns a material percentage
of the bank’s voting shares and relatives of the natural person.
• Subsidiaries or other affiliates of the bank.
• Any entity in which the bank directly or indirectly owns a sufficient percentage of
the shares to enable the bank to influence its operations.
Liquidity —Liquidity is the means by which a bank ensures that it can always
pay what it owes on time, which is vital to confidence in it and so to survival. This
is usually achieved by some combination of a well diversified asset base, holding
readily marketable liquid assets, managing the maturity profile of assets and liabili-
ties, and borrowing-lending in the interbank market.
Capital adequacy and the risk-asset ratio —Capital adequacy is the

amount of capital required by the regulator for the business the bank conducts or
intends to conduct. It may take various forms especially a mix of equity, preference
shares, and subordinated loan capital. In practice the regulators will decide the
bank’s minimum requirement. In approaching this decision they will consider the

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risk profile of each function appropriately weighted for quality. Weightings are
decided by the regulators and reflect international standards. The total of the
weighted risk amounts is then compared with the bank’s capital to calculate its
risk-asset ratio. This is the primary means by which the regulator and the board
can monitor capital adequacy.
Globalization —Globalization has many dimensions. It may refer to:

• The increasing ease with which business may be conducted in any part of the
world, due to improvements in information technology.
• The increasing tendency for financial institutions (or other business) to establish
a presence in many countries to facilitate the conduct of business.
• The gradual adoption of uniform standards around the world (for example in
accounting and auditing).
• The growing possibility of obtaining employment in any part of the world for
those possessed of the necessary skills (such as computer programming).
• The gradual adoption of one particular language as a convenient way of
facilitating business globally.
Independence —The legal systems under which most banks are structured tend
not to distinguish in a formal sense between different classes of director; in law all
have the same basic duties. It is generally the case that some directors have
executive duties and may therefore be known as executive directors. Directors
who have no such responsibilities are therefore known as nonexecutive directors
(or nonmanagement directors, or in some cases as outside directors). It is, however,
often the case that a director without executive duties may have or have had
some other connection with the company, for example:
• Having had executive duties in the company in recent years.
• Being a member of a firm that provides professional or other services or goods.
• Being connected to the managing director(s) or any senior director or officer
by blood.
Such people may have an important contribution to make to the board and the
company but they cannot be said to be independent.
Independence means their being independent of management—objective in their

appraisal of situations and unfettered in the opinions they express.

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Independence is an attitude of mind and an attribute of character. Apart from the

three circumstances listed above, independence may be compromised if directors
are under any financial or moral obligation that might curtail their freedom of action;
this may be the case if for instance they regard their appointment as being an act
of patronage by the chairman or CEO to whom they therefore owe personal loyalty.
Independence means not yielding to threats or blandishment, but forming a view

on the basis of the best available evidence and standing one’s ground. Maintaining
independence does not imply solitariness; concerns can be shared with independ-
ent colleagues. Independence means putting the bank first, come what may.

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2 . C O R P O R AT E G OV E R N A N C E
The interest in the systematic way in which companies, including banks, are
directed and controlled is relatively recent (arising over the previous 25 years). It
was stimulated in the first place by concerns about fraud and later by the failure to
correct evident managerial incompetence.
Recently there has been more concern to
Good governance requires sound facilitate investment and capital flows. All
three aspects are united in a simple theme.
structures and process. Checks If a company wishes to attract investment it
needs to be able to show it is well and hon-
and balances are vital to ensure estly run and that the information it pro-
duces is comprehensive and accurate.
that power is not abused. Viewed by potential investors, it would be
unwise of them to risk their savings unless
these conditions are satisfied.
Experience has shown that good governance requires sound structures and
process, and that checks and balances are vital to ensure that power is not abused.
This has implications for the role and composition of the board, the creation of com-
mittees of the board especially the audit committee, and the contribution that inde-
pendent outsiders could make to the decision process and to monitoring.
The emphasis of corporate governance developments has throughout mainly been

on control and monitoring—and rightly so given the failures, frauds, and flows of
misinformation that stimulated the reforms in the first place and are still a matter of
concern today. Good corporate governance will improve economic benefits and
this means vigorous enterprise as well as effective controls. Without enterprise a
bank will go nowhere, however well it is controlled. The need for systems of con-
trol does not eliminate the need for enterprise—new products and services, and
new markets.
Opportunity and risk are two sides of the same coin, but seeing opportunities
requires flair, often a sort of creative genius, whilst systematically keeping risk
under control is a relatively mundane but essential part of the process. A real danger
arises when an entrepreneurial genius has started a business successfully, has
become convinced of his own ability, and is irked by constraints. Long-term success
depends on a balance between enterprise and control and high standards of both.

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The economic benefits of good

Several themes are reflected in the governance affect a wide range of
people—depositors, employees,
manual: appropriate structures, creditors, shareholders and other
investors, the community, and the
appropriate process, integrity, and country itself.
transparency. Underlying them all is Several themes are reflected in the

manual: appropriate structures,
the general principle that continuing appropriate process, integrity, and
transparency. Underlying them all is the
prosperity requires a systematic general principle that continuing pros-
perity requires a systematic approach
approach both to enterprise and control. both to enterprise and control.
There is an identity of interest

between bank directors and banking supervisors in respect to corporate gover-
nance. They both want it to be as sound as possible and to be effective and effi-
cient. It follows that directors and supervisors should work closely together to
achieve the best results. It is in that spirit that the following sections of guidance
have been drafted.

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3 . T H E FO R M A L S T RU CT U R E O F T H E C O M PA N Y
The Legal Form
There are various kinds of legal structure designed to facilitate the conduct of busi-
ness, each with their own statute and set of laws and rules. These include partner-
ships and mutuals. None is a creature of nature, so we must look to the law to
determine the way they are to be governed. The basic form for banks is that of the
limited liability company (whether or not the shares of the company are quoted
and traded on a stock exchange).
The framework of the limited liability company is designed to:
• Facilitate the aggregation of capital. Companies are an effective way of mobilizing

the savings of a far wider and more numerous section of the population than is
convenient with other forms of enterprise. In the industrial sphere investors, that
is to say shareholders, have the protection of limited liability and this is also
generally the case with banks too.
• Create the possibility of “corporate immortality”. Unlike partnerships and several

other forms of organization a company does not dissolve when one of the partners
dies or resigns. Companies can in principle survive indefinitely. There are examples
in some countries of companies that are well over a century old.
• Provide for the concentration of the power to manage. For a bank or any kind
of business to prosper there must be the power to manage the enterprise, and
this must be concentrated enough to be effective. Such a concentration is
especially necessary to deal with long-term projects,
Banks are generally subject to special laws in addition to the basic law governing
companies (in the UK, the Companies Act). Banks everywhere are supervised
either by their central bank or by a specifically empowered body such as the
Financial Services Authority (FSA) in the UK. The reason for this additional law and
supervision is due to:

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• Their importance at the centre of every country’s financial commercial and

industrial framework.
• The nature of their business, which means that they are highly geared.
• The wider effects of their demise, which affects depositors as well as trade cred-
itors and shareholders.
The Division of Company Functions
The role of the three parties in a limited liability company can be described in gen-
eral terms, with the directors in a pivotal position between shareholders and man-
agement. The shareholders provide the equity capital. Their powers are important
but limited. They alone can appoint and dis-
miss directors. Their agreement is required
Directors owe their loylaty to for certain types of transaction (specified
either by the general law or by the compa-
the company and are accountable ny’s by-laws), such as raising new capital, or
major acquisitions and disposals.
to the shareholders. Managers
The directors are entrusted by the shareholders
are appointed by and are with the running of the business. They owe
their loyalty to the company and are account-
answerable to the directors. able to the shareholders for their stewardship.
Accountability implies transparency.
Managers are appointed by and are answerable to the directors, and have author-
ity delegated by them for running parts of the business. Directors may, and in the
early stages of a business usually do, have managerial responsibilities too. When
this is the case they need to be aware of their dual responsibilities. They are at the
same time responsible for specific operations or functions and are also part of the
collective decision making process of the board.
This formal division of functions may be obscured if the same person is simultane-
ously a major shareholder, a director, and a manager. This produces a concentra-
tion of power with few checks and balances. This arrangement can work well,
even spectacularly so for a period of time, but its weakness is that it may be diffi-
cult to deal with problems that arise when the leader falters because it is difficult to
control him or bring in new blood. Corporate governance reforms have been

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designed to mitigate some of these effects but a dominant founding father of a

business is notoriously hard to keep in check. This is an area of especial interest
to the supervisors.
There is another dimension to accountability in respect of what are sometimes

called stakeholders, people who have an interest in the bank’s prosperity but do
not necessarily hold shares in it. They include the depositors, customers, employ-
ees, suppliers, existing and potential shareholders and investors and local commu-
nities. The directors are not accountable to any of these groups but must take full
account of their interests as the bank is most unlikely to succeed otherwise. To
neglect any of them is to invite problems and difficulties. A concern for stakehold-
ers is a part of what has come to be called corporate social responsibility.

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4. THE STRUCTURE AND COMPOSITION OF THE BOARD
The board, as well as the company, needs a leader and should elect one of its
number to act as chairman (the appointment will generally need the approval of
the regulator). It is his task to lead decisions on the composition of the board itself.
His responsibilities always include the preparation for and conduct of board
meetings. He will sometimes be the public face of the company in reporting on its
progress. He may not have any other executive responsibilities and may therefore
be part-time.
The chairman of the board may be the CEO too, or the roles may be divided.
Except in small banks, dividing the roles is normally recommended, partly because
the workload of doing both jobs is
significant, partly because dividing the two
A balance is required on the improves the operation of checks and balances
and lessens the likelihood of a concentration of
board between the executive power becoming dangerous.
and nonexecutive directors. Where there is a separate chairman, he and the

CEO may decide together on the allocation of
functions. The task of representing the compa-
ny to investors may for instance be divided or left to the CEO, or indeed shared
more broadly, typically with the finance director or the head of investor relations.
As noted above, the effective governance of the business requires the board to
strike a balance at a high standard of effectiveness, between driving the business
forward and controlling it prudently. This in turn requires a balance on the board
between the executive and nonexecutive directors. This balance will be assisted if
some and preferably a majority of the members of the board are independent (as
defined). In the last resort, any board should be able to challenge and stop its
CEO or managing director(s).
‘Independence’ is defined in the glossary above. Independent directors must be

people of character and relevant experience. They will often have a valuable
constructive contribution to make both on and off the board because of their
knowledge and contacts.
If any institution does not appoint independent directors, it is all the more important
that all the executive directors exhibit the qualities of independence—not always

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easy as the chief executive is their superior. This is another reason why the chief
executive should not be chairman too. It leads to an overwhelming concentration
of power which it is tempting to abuse.
Boards should be no larger than strictly necessary for the conduct of business,
even when they include appointees from large shareholders. The larger boards
get, the more likely it will be in practice for serious decisions to be decided by an
inner committee beforehand.
An ideal board will include members with a wide

The chief executive should range of different backgrounds and some perhaps
with special financial, technical, or marketing
not be chairman too. It skills, others perhaps with a breadth of other
experience. Recent U.S. legislation requires a
leads to an overwhelming member of the audit committee and therefore of
the board to have a high degree of financial liter-
concentration of power acy. If the bank is trading in complex derivatives,
the minimum standard required should be that
which it is tempting to abuse. one member of the board at least should be
sufficiently knowledgeable to understand and
question them. The general objective of having
various skills is not to substitute their experience for expert advice, which the
board will need in particular situations, but to ensure that matters are appropriately
considered. The regulator’s approval is generally required on every appointment to
the board and it will take into consideration its balance and composition.
Assessing how well the board works and the contribution, both on and off the
board, of its individual members is delicate and difficult, but it needs to be done.
One of the reasons for giving directors a specified term, which should be the rule,
is that reappointment provides a convenient occasion for such assessment.
This does not preclude reappointment by common consent, but all boards need
periodically to refresh the membership and make changes.

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5 . R E S P O N S I B I L I T I E S O F T H E B OA R D S O F
D I R E CTO RS O F BA N KS
General Responsibilities
Banks are different from the generality of companies in that their collapse affects a
far wider circle of people and moreover may undermine the financial system itself,
with dire effects for the whole economy. This places a special responsibility upon a
bank’s directors. This responsibility remains with them even though they operate
under the supervision of a regulatory authority whose task is to ensure their
business is conducted in a way that is conducive to stability. Their regulators’
concern will be with the quality of the bank’s management, starting with the board
of directors itself.
As directors cannot do everything themselves and must delegate, they must

constantly keep in their minds the capacity of those to whom they entrust authority
and the framework for checking its sound, sensible, and honest use. Unless they
do this they cannot claim that they have discharged their responsibilities. Each
director individually and the board collectively should consider themselves respon-
sible for the effective and efficient manage-
ment of the bank.
Each director individually and
They will need to meet as a board as often as
the board collectively should the conduct of business requires but never
less than quarterly. It is the chairman’s task,
consider themselves responsible supported by the company secretary to
ensure that an agenda with the relevant sup-
for the effective and efficient porting papers be circulated to all members at
least seven days beforehand. The chairman
management of the bank. must ensure that the order of the agenda and
the conduct of meetings do justice to the
importance of the issues before the board.
Minutes of the meeting’s conclusions should be circulated in draft within seven
days afterwards. They should record the principal arguments but not normally
attribute them to individuals. Individuals who dissent from a decision the board has
reached may require the secretary to record the fact in the minutes. The minutes
should state where the responsibility lies for executing agreed decisions.

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The board must timetable all its meetings in advance for the coming year including
a timetable for reporting from all the relevant committees and the internal and
external auditors.
In countries with unitary boards, some directors will have two sets of duties, those
duties that flow from their position as directors and their executive duties. Whether
they are nonexecutive or executive directors the main elements of their work are
described below.
Enterprise
The main elements of the directors’ duties relating the overall enterprise of the
bank are:
• To support management in its task of driving the bank forward and, to that end
to encourage innovation.
• To consider with great care the
bank’s human, physical, and finan-
Integrity is indivisible. It is the
cial resources and its strength and
weaknesses. Therefore to agree,
example of the directors themselves
against this background, its aims,
long-term strategy, and its medium
that constitutes the most persuasive
and short-term business plans,
bearing in mind at the same time the
statement about ethics.
external economic environment in
which the bank will be operating.
• To make sure that plans are communicated throughout the organization to those
who will be affected by them.
• To institute and support a clear framework of policies and objectives in all
spheres within which management must operate. These would cover personnel
policies, the basic financial regime including budgeting, and financial operations
including asset and liability management, capital planning, and investments.
• To deal with mergers and acquisitions.
Leadership
With regard to leadership the director’s duties are:

• To set the tone for the behaviour of all the bank’s employees by example and
prescript. Integrity is indivisible. Statements about the bank’s corporate values

17553_GCGF 10/17/03 5:27 PM Page 17
and ethical policy should be short, simple, and made available to everyone; but it
is the example of the directors themselves that constitutes the most persuasive
statement about ethics.
• To disclose any possible conflicts of interest in matters before the board and
abstain from participating in the discussions on it and refrain from voting (which
should be minuted).
• To ensure that the bank’s operations conform to all applicable laws.
• To encourage the confidence of depositors and clients in the integrity of the flow of
information from the bank. Directors must recognize the dictates of commercial
confidentiality, but never use this as an excuse for unnecessary opacity. They should
consider transparency to be the norm; the burden of proof rests with those who
would wish to limit it to show that commercial necessity has to be paramount.
• To solve the problems posed
by related party transactions.
Directors must recognize the dictates of A well-run bank will have
developed systems for
commercial confidentiality, but never use this assessing and monitoring
loans and for addressing the
as an excuse for unnecessary opacity. They element of risk in any kind of
transaction. It will have devoted
should consider transparency to be the norm. resources to promulgating
rules and to training staff on
how to apply and monitor
them. It is confusing to the staff if they are put under pressure to relax the rules
on the grounds that a particular party is privileged perhaps through consanguinity
or because of an outstanding obligation. Such relaxation may mean participating
in a transaction they would otherwise have declined; or doing so on unusually
favourable terms; or allowing situations to develop that should have be faced
sooner (like calling in a loan that has become dubious). The board should decree
that a credit assessment should always be conducted on the ‘arm’s length’ principle
and never be affected by such considerations, and no course of action that would
normally be considered inappropriate should be pursued—including settling old
scores by inappropriate harshness. Related party transactions should be listed in
the annual report.
The distortions caused by related-party obligations extend far wider than loans and
include contracts and employment. The board needs to make sure that the bank is
not being injured thereby.

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Reporting
Although increasing responsibility now rests with audit committees (see below) for
vetting financial statements and discussing them with the auditors, the ultimate
duty to ensure that any reports issued
by the bank, including the financial
The ultimate duty to ensure that any statements, present a true and fair
view of its position and performance
reports issued by the bank present a still rests with the board as a whole.
Whatever advice they receive and
true and fair view of its position and whatever the formal requirements, it is
not acceptable either by statements
performance still rests with the board. or omissions to knowingly present a
misleading picture.
Communication
Directors should ensure that there is an agreed communications strategy and pro-
cedure including agreement about appropriate channels and spokesmen. This
includes a decision on what part, if any, independent directors may play. It is too
late to start considering such matters when a crisis strikes.
Controls
In relation to controls and the control environment director’s duties are:

• To ensure that the board receives periodical reports about the financial position
of the bank and its performance in the form (including the degree of detail) and
at intervals most appropriate to its business.
• To monitor progress towards the bank’s objectives (this will often be set in the
context of performance against budgets).
• To ensure that its operations are properly controlled and to this end to set and
enforce clear lines of accountability and responsibility throughout for identifying,
managing, and reporting on risk (see below).
• To ensure that there are sound systems for decisionmaking and control and that
the systems are effective by having them regularly tested and reported upon.
• To ensure that the managerial responsibility for each system is in sound hands
and that managers know the risks they ‘own’.

17553_GCGF 10/17/03 5:27 PM Page 19
• To ensure there is an effective internal audit arm with a direct reporting line to the
CEO and the right of access at all times to the chairman of the audit committee.
• To receive reports from the auditors, management, and the audit committee on
material breaches of laws, rules, and supervisory regulation (including instruc-
tions from the regulatory authority which may come in the form of formal or
informal administrative action) and ensure that management takes the necessary
action (see also the audit committee below).
• To ensure that managers address all security-related matters and receive expert
advice on the design, planning, and implementation of security standards, pro-
cedures, and systems covering all aspects of physical and technical security
aimed at safeguarding the assets and operations of the bank. Breaches should
be reported, and serious incidents or shortcomings should be brought to the
attention of the board.
• To establish clear written policies in regard to Treasury operations and receive
reports regularly on them together with any breaches of these policies.
• To establish clear written rules on investments and require regular reports in
respect of them.
• To ensure that written rules are promulgated to prevent fraud and deal with it if it
is suspected or discovered. Frauds and suspected frauds should be reported at
once, and in any case management should be required to report any incidents
at six monthly intervals. (Fraud is covered in more detail in annex 2).
• To satisfy themselves that the bank’s arrangements for detecting and reporting
money laundering conform to official advice and instruction. This may require the
board to appoint an official with responsibility for a regime against money laun-
dering. (In the UK this means appointing a money laundering reporting officer in
accordance with the FSA’s instructions. The FSA’s approval is required to the
appointment.) In larger banks the official will need the support of a special
money laundering control unit. In all cases the board should ensure that staff
receive a manual to tell them what is required of them. The board should
consider carefully how to encourage staff at all levels to be alert to suspicious
transactions—as well as making it known that turning a blind eye will not be
tolerated. An effective operation against money laundering will help safeguard
the bank’s reputation and assist the authorities in their struggle against organ-
ized crime. (A background note on money laundering is presented in annex 3.)
• To ensure those operations abroad have a well-considered remit and are careful-
ly monitored and controlled. Directors will bear in mind that operations overseas,
especially in the main financial centres are fiercely competitive, and that this

17553_GCGF 10/17/03 5:27 PM Page 20
imposes exceptional strains on the bank’s officials in the form of the quality of
local staff they are able to recruit and the risks they are assuming in their efforts
to build up the business.
Human Resources
With regard to human resources, directors’ duties are:

• To select competent executive officers and dispense with the services of the
inadequate.
• To promulgate policies designed to maintain the quality of management by
sound appointments. It is vital that at all levels of management should
know their staff and have ascertained that they are fit and proper for the
work on which they will be engaged. Their competence and honesty should be
above suspicion.
• To establish programmes for
training and retraining at all
Poor leadership infects. The appointment or levels including board
members themselves.
dismissal of the CEO is in practice the single Independent directors
should have a course of
most important function of the board. induction on appointment to
familiarize them with the
company’s operations. All
directors on first appointment should be taken through this guidance to familiarize
them with the functions of the board and its committees.
• Where necessary, to transfer or remove the inadequate. Poor leadership infects.
The appointment or dismissal of the CEO is in practice the single most impor-
tant function of the board.
• To develop a policy for staffing internal audit. It should NOT be regarded as a
place to dump people who are unsuitable for line management. Internal audit
needs high-quality staff. One possibility is to make it general practice that the
liveliest shall serve there for a spell from time to time in the course of their
careers.
• To ensure that the system of remuneration in the bank is satisfactory.
• To protect members of the board by insuring them against personal liability
(see annex 4).
• To decide the process by which the board itself is to be assessed, both in
terms of the way it works together and of the contributions made by individual

17553_GCGF 10/17/03 5:27 PM Page 21
directors (including their contributions outside board meetings). There is no set

way of conducting this business - which is delicate, as it touches directly the
use of power. It might for instance be delegated to a special committee or to the
nominations committee. In either case, the board may wish to seek the help of
an outside specialist to provide an objective view.
Financial and Other Physical Resources
Directors’ duties with regard to financial and other physical resources are:
• To monitor liquidity and the financial position regularly (normally monthly).
• To monitor the adequacy of the bank’s capital. Directors will understand that the
bank’s capital protects its depositors against possible losses. They must decide
the form and quantum in the light of the types of business it proposes to solicit
and conduct and the risk attaching to each. They will be aware of the need to
make the best use of capital in order to provide investors with a satisfactory
return and at the same time not to underestimate the credit, market, and opera-
tional risks that attach in varying degrees to particular types of business.
Regulatory supervisors weight the risks to reflect the qualitative factors (in the
light of international standards) and compare the weighted risk with the bank’s
capital to calculate its risk-asset ratio. This is the primary means by which the
regulatory authority and directors can monitor capital adequacy.
• To make sure, through the risk management committee or its equivalent, that
management has put in place the necessary insurance policies, using professional
insurance advisers, and to receive an annual report on the insurance coverage
and the quality of the insurance companies with which the business is placed.
Structure of the Company
Directors should decide on the operational structure of the company in the light of
the proposals made by executive management.
Proposals for reorganizations and restructuring should be examined with care as

they are always costly and disruptive. The board should review such proposals
carefully to ensure that the benefits suggested are worth the additional strain they
impose.

17553_GCGF 10/17/03 5:27 PM Page 22
A change of control or management often brings with it proposals for structural

change, sometimes on the grounds that the reorganization will achieve savings.
The board should take the greatest care to ensure that projected economies and
savings are realistic and are in fact obtained.
Mergers affect people who will naturally fight to defend their own position.
Obtaining so called ‘synergies’ is generally far more difficult than projected and
puts great pressure on managers and responsibility on the board.
The Audit Committee
With regard to the audit committee, directors’ duties are:

• To establish an audit committee with terms of reference recorded in a formal
board minute and to select the members of the audit committee from the inde-
pendent directors. Besides the personal qualities of judgment and character,
members should be chosen for their experience and acumen and their capacity
to handle the reports they will receive about risk and the operation of the bank’s
various systems. As noted above at least one member of the audit committee
should have a sufficiently sophisticated knowledge of financial matters to deal
with the more abstruse instruments in which the bank trades.
• To institute a process of induction for new members of the committee in relation
to their duties and encourage them to familiarize themselves with the operations
of the company at home and abroad.
• To refresh its membership as needed to maintain its skills and commitment
• To approach the selection of the chairman of the audit committee with especial
concern about his strength of character and independence from the executive
and management. Potential conflicts of interest should be avoided, and this
rules out the chairman of the board serving as chairman of the audit committee
even if he is not the CEO.
• To empower it formally so that is well equipped to execute its functions. The
board should give it the right to:
◆ Have direct access, without management present, to the head of internal
audit, to the senior partner of the accounting firm conducting the audit, and
where necessary to the partner of the firm of actuaries advising the bank.
◆ Have access to any employee.
◆ Conduct such investigations, as it thinks fit.
◆ Obtain such professional advice, as it thinks necessary at the bank’s
expense.

17553_GCGF 10/17/03 5:27 PM Page 23
• To monitor the functioning of the committee and approve, at regular intervals, a

statement of its programme for discharging the responsibilities the board has
laid upon it; this will include a report on the frequency of its meetings, and its
relationship with external and internal auditors supervisors and examiners.
• To commission and receive reports about the reappointment and remuneration of
the external auditors and submit their conclusions to the annual general meeting.
The chairman of the committee should be in attendance to respond to questions.
Credit Facilities
it is the board’s task to establish the
Various structures and processes
policies within which loans are granted are used for granting and monitor-
ing facilities Some banks operate
and monitored, and to make sure that the on hierarchical lines with clearly
specified limits of authority at
bank has the appropriate structures, different levels. Others rely more
on committees. In many cases,
procedures, and lines of reporting and especially in large banks operating
internationally, there may be some
clear definition of responsibilities. form of matrix controls and proce-
dures in which both product and
region figure. Whatever the
choice, it is the board’s task to establish the policies within which loans are granted
and monitored, and to make sure that the bank has the appropriate structures,
procedures, and lines of reporting and clear definition of responsibilities. Nothing
must fall between the cracks. Such policies should address among other matters,
any geographic or sectoral issues, (such as personal mortgages, agriculture, and
commercial real estate) and maturity.
Officers and managers (and committees) that consider applications for loans,
letters of credit, and acceptances should be instructed to report on an applicant’s
total liability to the bank. The board needs to decide how best the loan review
process is reported to it and to what degree of detail.
In addition to the above, the directors duties are:

• To ensure that appropriate officials or committees receive reports monthly on
new credit facilities (other than small ones) and also full particulars of those that
are overdue or in default (together with details of the proposed recovery action).

17553_GCGF 10/17/03 5:27 PM Page 24
• To ensure that all credit facilities are monitored annually at the appropriate level.
• To consider liabilities in aggregate and their funding.
• To sanction the writing off of material nonperforming debts. The board will have
decided beforehand the limits of delegated powers and how it defines ‘material’.
The board should recognize that officers are naturally reluctant to admit that
credit facilities they have sanctioned are going wrong and should encourage
them to overcome their reluctance to report incipient problems.
• To establish in writing a provisioning policy. The board should be cautious and
conservative in making provisions for facilities where the risk of loss is high and
should be prompt in writing them off if they prove irrecoverable.
• To ensure that the valuation and classification of assets is appropriate and that
there are proper reporting arrangements to the board on material issues.
Risk Management
The operation of a bank or financial institution inevitably means facing risks of

many kinds. The board will know that handling risks of any kind should start with a
systematic analysis of the two elements of materiality: probability and impact.
Probability is the likelihood of the event occurring, and impact is the damage that
might be caused if it did.
The board’s task is:

• To deal with strategic risk. Such risks affect a bank’s basic policies and cannot
be delegated, even to the audit committee. They need to be considered sys-
tematically. For example, is the bank in the right markets? Are its products and
services appropriate and competitive? What threats are posed by competitors?
What weaknesses must be addressed? This type of assessment is sometimes
called SWOT analysis - Strengths, Weaknesses, Opportunities, and Threats.
• To ensure there is an adequate system for handling all other kinds of risk, that
each is ‘owned’ by specific managers or committees, and that the systems
work and are objectively tested. The board should receive regular reports
affirming their effectiveness and any material failures together with details of how
the matter is dealt with. The board will recognise that some risk always remains
a residual risk, which management must identify and accept.
• To establish the structures and processes for granting and monitoring credit
facilities and to monitor and to consider applications that cannot be dealt with
under delegated authority.

17553_GCGF 10/17/03 5:27 PM Page 25
Compliance
The volume and complexity of legislation and regulation that now applies to
companies in general and banks in particular are so great that no director could
reasonably be expected to master all the details. Nevertheless all directors should:
• Know what the scope of the main laws and regulations is;
• Ascertain where within the company expertise lies;
• Know how compliance with the law is assured; and
• Receive reliable reports on compliance and any material failings.
Some provisions are so important that a wise bank director will familiarize himself
with them.
If the bank is quoted on a stock exchange, directors should be aware or the

obligations that flow therefrom, in stock exchange listing rules, codes of corporate
governance, and so forth.
Social Responsibility
Directors should ensure that the bank follows policies that are socially responsible
in all relevant areas including care for the environment.

17553_GCGF 10/17/03 5:27 PM Page 26

17553_GCGF 10/17/03 5:27 PM Page 27
6 . C O M M I T T E E S O F T H E B OA R D
Running any kind of financial institution requires carefully planned, executed, and
monitored systems at every point. These are essential to ensure that funds in the
business are deployed sensibly, do not go astray, and can be traced after transactions
have occurred. Risks are unavoidable but need to be considered systematically.
A systematic approach engages everyone in the business, as it covers all activities.

It is no use having systems unless everyone works within them and is committed
to do so. This means that they must be
well-designed and as simple as possi-
It is no use having systems unless ble whilst being effective. They must be
clearly understood by those who have
everyone works within them and is to operate them. This will mean train-
ing, as systems tend to become more
committed to do so. This means that sophisticated technically. They must be
tested, and here the internal and exter-
they must be well-designed and as nal auditors have their part to play.
They must be periodically reviewed to
simple as possible whilst being effec- see how they can be improved.
tive. They must be clearly understood In practice boards establish commit-

tees to help them ensure that the bank
by those who have to operate them. is being soundly managed; most banks
have an executive committee as well
as an audit committee (which is
mandatory). These and the other main ones are discussed in detail below. It is
however crucially important for the board to ensure that committees should facili-
tate the conduct of business and do not unnecessarily impede it, by, for instance,
duplicating the work to be done or getting lines of communication crossed. In
banks the speed of reporting and decisionmaking is often crucial.
All committees derive their powers from what the board wishes to assign to them;
the board may delegate but can never abdicate responsibility. It is for the board to
establish the terms of reference in every case and ensure they are appropriate. It is
also for the board to name the chairmen and members, and to arrange how the
committees should report. It is for the board to monitor the committees’ effectiveness.

17553_GCGF 10/17/03 5:27 PM Page 28
The chairman of the bank should keep the regulatory authority informed of the
existence of committees of the board together with their terms of reference and
membership. The names of committee chairmen and members should be listed in
the annual report.
The Executive Committee
It is common practice, but not mandatory, for banks to appoint an executive com-
mittee comprising senior line and staff managers with the CEO (or managing direc-
tor) as chairman. This is a convenient way to separate the task of running the insti-
tution on a day-to-day basis from the consideration of longer-term strategic mat-
ters. It is for the board to decide its terms of reference and lay out the matters that
should be reported to it for information or decision. Many of the matters of which it
disposes will not be material enough to warrant the attention of the board. There
are, however, many matters which are on the borderline, and it is a matter of judg-
ment as to which need reporting. There will be an overlap between the member-
ship of the board and that of the executive committee. It is common practice for
the finance director to be a member of both, and for that matter any member of
the board with significant executive responsibilities.
This committee will meet far more often than the board—at least monthly and per-
haps fortnightly or weekly. It can be summoned at short notice to deal with any
significant issue.
It is common practice for the chief executive to report to the board on any major
issues that have arisen; in most cases he will have ensured by prior discussion
with the chairman of the board which items should appear on the board’s agenda.
The executive committee is a convenient body to deal with specialized subjects

which are not the province of any other committee, for instance human resources,
information technology, insurance, or environmental matters. Whether any of these
subjects deserves a separate committee of its own is a matter of convenience
depending on the length of the agenda and significance of the subject.
The executive committee can also serve usefully as a forum in which ideas and
problems can be discussed informally.

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The Audit Committee
Appointing an audit committee is sound practice, and many consider it indispen-

sable. Most regulators require banks to do so.
The key features of a good audit committee are its thoroughness and its
independence. It will not, for instance, allow itself to be pushed around on the
accounting treatment of results or by obscuring issues raised by related-party
transactions.
Audit committees play a key role in financial control and reporting, thus strength-
ening corporate governance and increasing public confidence. In helping to pro-
tect the bank’s assets, they are serving the interests of shareholders, investors,
depositors, regulators, and all who work in and have dealings with the bank. They
are allies of the banking supervisors and should work closely with them. Even so,
it is important for the members of the audit comittee to be independent of the
supervisors themselves.
Composition. The audit committee of three to five members will be appointed by

the board and should be formed exclusively of members who are independent of
management. The members of the committee will have been considered and
approved by the regulatory authority on first appointment to the board. The maxi-
mum period for an initial appointment should be three years. It may be renewed
periodically with the agreement of the parties and of the regulator.
The chairman. The board will appoint the chairman of the audit committee. He
sets the committee’s style, tone, and agenda; its effectiveness rests heavily on
him. It is therefore crucial that he be independent as defined above. He will find
the task is increasingly time consuming as it necessitates meetings with the inter-
nal and external auditors as well as the finance director (or chief financial officer) if
the job is to be done thoroughly.
Remuneration. The remuneration paid to the chairman and members of the audit
committee should be published in the annual report.
Meetings. The committee should meet as often as the dispatch of business

requires. Three or four meetings in a year would be usual (plus any additional
meetings with the external auditors felt to be necessary). The chairman will so

17553_GCGF 10/17/03 5:27 PM Page 30
arrange meetings that at least twice a year the committee can meet the external
auditors without management being present; and with management without the
external auditors being present. Ideally the decisions the committee reaches will
be unanimous. If there is a vote and it is deadlocked, the chairman’s view shall
prevail.
Members of the bank’s management including the general manager or CEO (and
any employee) may be invited to attend. The finance director will also normally be
invited too. The internal and external auditors will normally be invited to attend.
The minutes of the proceedings of the audit committee will be circulated to all
members of the board and the chairman of the board as soon as possible and
placed on the agenda of the next meeting of the board when the chairman of the
audit committee will draw the board’s attention any material issues in the minutes
or that have arisen subsequently.
Relationships with the regulators. The audit committee should see itself as an
ally of the regulators; they share a concern for sound controls and accurate infor-
mation. It follows that there should be close cooperation and openness. This
implies liaison with the regulator and, where required, any appropriate foreign reg-
ulatory authority. If the regulator issues instructions or makes recommendations
the committee must get reports from the bank’s managers that they have been
put into effect.
The chairman of the audit committee may be required to meet representatives of

the regulator with executive colleagues (and in exceptional circumstance, alone).
He should of course cooperate but resist pressures so to extend the scope of his
office that it impinges on the domain of executive management.
Functions. The four major functions of the audit committee are described below.
• Financial reporting
To improve the quality of financial reporting by reviewing the financial statements
before the board considers them, focusing particularly on changes in accounting
practices, significant adjustments resulting from the audit, and compliance with
accounting standards. Whatever the formal requirements, the committee must
satisfy itself that what is being presented produces a true and fair picture of the
company’s position and performance (the effective conduct this task will help to

17553_GCGF 10/17/03 5:27 PM Page 31
raise the standards of and confidence in financial reporting and auditing). Part of
this task, for which they will look to internal audit, will be to ensure that income
has not been overaccrued, that expenses have been accrued and not hidden or
capitalized, and that ‘off balance sheet’ transactions do not actually or potentially
have a material effect on the situation.
• Controls
◆ To appraise, improve, and reinforce the control environment. As part of this, it
will review the statement on corporate governance and internal controls in the
ensuing annual report. This includes the design, operation, manning, and test-
ing of the system of control, thus enhancing a climate of discipline and control
and reducing the opportunity for fraud. In the course of this function, it will
have reviewed the relevant management reports and the information required
by the regulatory agencies.
◆ To review the bank’s system of risk analysis and controls and ensure they
work and are cost effective.
◆ To require management confirmation that they have introduced and main-
tained a sound financial reporting system and to obtain assurance from the
auditors that it does in practice generate accurate, reliable, and timely infor-
mation.
• The internal and external auditors

◆ To improve communication with internal and external auditors so as to
enhance their independence. This is achieved by meeting the auditors regularly
to check on their relationship with management, to discuss any emerging
issues, to assure themselves of the auditors’ continued objectivity and inde-
pendence, and to review and agree their audit plans for the ensuing year and
the execution of these plans. One of the most valuable functions of the com-
mittee is to improve communication with auditors and enhance their status.
The chairman of the committee should provide both the external and internal
auditors with direct access to himself any time they request it. He should meet
the partner of the external auditors, who is in charge of the audit, once a year
one to one.
◆ To review periodically the remuneration and performance of the external auditors
and ensuring they maintain their objectivity by agreeing a change of senior
audit partner every five to seven years. The audit committee should propose
to the board when they deem it wise that a replacement firm be sought. In
inviting tenders, the committee will set out the type, scope, and plan of the

17553_GCGF 10/17/03 5:27 PM Page 32
audit required. In making its selection, the committee will assess the ability of
the particular partner(s) a firm proposes to put in charge. The committee faces
a dilemma when contemplating change. It knows that a new firm will take time
to get to know the bank as well as the present auditors, that a whole new
series of relationships will have to emerge, and that there is much work and
some cost in the process of change. At the same time auditors can get too
close, or they can run out of steam.
◆ To ensure that the external auditors’ independence is not compromised, and
is not in danger of being compromised, by their fees from the audit becoming
secondary to those they derive from other services such as consultancy. It
may make sense for them to render services that link closely with the audit for
instance in tax matters, but the committee should encourage and if necessary
require management to use other firms on other project work, in connection
with a takeover and consultancy. This also gives the committee a chance to
get to know of other firms and assess their competence.
◆ To play its part in promoting the efficacy of internal audit and support it. It shall
have the right to approve appointments to that department. The committee
will find itself relying heavily on internal audit in the whole area of systems and
controls. It will form a view whether its resources are adequate and its staff
good enough. It may be assisted in its views by advice from the external audi-
tors with whom the internal auditors should have cooperated.)
◆ To receive on behalf of the board relevant extracts from internal audits reports
and draw to the attention of the CEO and the board any material matters in
them. The chairman of the committee should receive all the reports but only
extract from them for the committee itself the relatively few items he judges
significant or material. It is imperative not to swamp the committee with paper.
◆ To seek advice on the latest developments internationally in accounting and
auditing and where material report these to the board. With the impending
changes it is imperative that members of the committee understand them in
principle and how they will affect the bank’s stated earnings. If necessary
members should seek advice in separate session from a firm of external auditors
• Adherence to laws, regulations, and guidance

◆ To review the external auditors’ management letter and management’s
response.
◆ To review compliance with the rules and observations of the regulatory
agencies, monitor the bank’s response, and report material deficiencies to the
board. It is for consideration how to organize the compliance function. The

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board may decide it necessary to appoint a separate compliance officer;

however, the essential features are that the responsibilities for compliance
are clearly allocated and there is an adequate system for ensuring it works
satisfactorily.
◆ To receive periodical reports, take the necessary action, and where appropriate
report to the board (at least annually) on matters relating to the integrity of the
bank, including breaches of rules and regulations on the laundering of money
generated by crime or drug- related activity (see below), insider trading, related-
party transactions, litigation, and significant violation of the bank’s moral and
ethical policies and its corporate code of conduct.
◆ Members of the audit committee, other directors, and managers must recog-
nize that the responsibilities resting upon the committee are numerous and
heavy. It is all the more important that the committee does not assume
responsibilities properly discharged by the whole board and become a quasi
supervisory board. It must not usurp the board’s functions—for instance, the
control of business risk.
◆ The committee may, as a result of various events, have observations on
particular people and should make these known to those responsible, but
they must remember that the responsibility for the competence of management
rests with line managers and ultimately with the CEO.
◆ The audit committee should not drown in paper or detail. Their business is
materiality, not minutiae. It is only too easy for others to evade responsibility by
dumping it on the audit committee; they should not try to do so, and the audit
committee should not let them.
The Remuneration Committee
Directors’ remuneration is a matter of concern to all who have an interest in the

bank and to the media. Therefore it is essential that there should be openness
about the total sums directors receive and the basis on which they are calculated
(broken down into all the relevant elements such as basic pay, bonuses, incentive
plans, or share options).
There is a potential conflict of interest for directors who decide their own remuner-
ation. It may help resolve this if the board appoints a remuneration committee
composed mainly of independent members to make recommendations to it about
the remuneration of members of the board. It is best if executive directors’ remu-
neration is considered against a background of the bank’s remuneration policy for

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its entire senior staff and its broader personnel policies. The committee should
examine closely the way incentive and bonus schemes are calculated, and they
should test the figures. They will also wish to examine with care compensation
arrangements for loss of office, especially where poor performance causes it.
The Nomination Committee
From time to time the board will wish to appoint new independent members, or
independent members of the audit and remuneration committees. It will help to
ensure a thorough and objective process of selection if a recommendation be
made to the board by a properly constituted nomination committee, itself including
independent members. Names proposed by the committee and approved by the
board will be cleared with the regulator in the usual way. The chairman of the
board (whether or not he is also CEO) may chair this committee.
The best procedure is for an objective and methodical process to be followed:

• The decision about recruitment.
• The formulation of a job description, answering questions such as what kind of
person should be sought.
• A formal or informal search (or both). This will include considering candidates
already known to members of the committee and the board.
• The creation of a short list of suitable candidates.
• Taking references.
• Interviews with members of the board.
The Risk Management Committee
This is sometimes called the asset and liability management committee. The board
may appoint one or more committees to deal with risk management other than the
management of strategic risk (as defined above) for which it has direct responsibility.
The terms of reference of these committees will be to establish the structures and
procedures for dealing with all other classes of risk.
Other than strategic risk, there are two main types of risk.
Process risks are sometimes called operational risks. These are dealt with in annex
1. Transactional risks include market risk and credit risk. These are discussed
below. It will be the committee’s main task, bearing in mind the range the bank

17553_GCGF 10/17/03 5:27 PM Page 35
wishes to undertake, to institute the necessary rules and procedures to cover mar-
ket risk and credit risk.
Market Risk. The first part of the committee’s work—which will be important but
in many banks relatively infrequent—will be to focus on risks associated with the
particular types of financial instrument in which the bank trades, such as foreign
exchange (forex), swaps, and Treasury dealings generally. The characteristics of
each of these instruments are their capacity to provide good profits or, if not prop-
erly controlled, to produce huge losses and even total ruin. It can and should
aggregate counterparty risks if it conducts various forms of business.
The committee’s task is to get to grips with the proposed type of business in a
particular market to control risk. It should sanction entry to the market (or not), lay-
ing down from the beginning what the limits are and establishing the rules about
reporting. The committee is in a position to aggregate the limits granted to particu-
lar managers or departments and so to
build up a picture of what the bank’s total
Managers should not undertake any exposures are, thus enabling it to prevent
the bank becoming overextended.
transaction unless they understand it
Derivatives of great complexity are now
fully, can measure its consequences, on the market. Some are so complex
and sophisticated that they are difficult to
and account for it properly. understand and the risks difficult to cal-
culate (there are cases where a failure to
understand and measure the risk involved
have cost even large banks considerable sums). The committee should not permit
managers to undertake any transaction unless they understand it fully, can measure
its consequences, and account for it properly. If they do so and problems emerge,
they should report them as soon as they have become apparent.
Adequate control of dealers is vital. They should know with absolute clarity what
the limits are. From time to time dealers inevitably make losses. The committee
should let it be known that timely reports of losses will not carry punishment.
Cases show that it is seldom a first loss that causes serious problems, but the
subsequent efforts (often concealed) of traders to rectify the position by trading
out of it. Management therefore needs to encourage dealers to own up to errors
and report breaches of limits as soon as possible. Those who exceed limits—even

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when they make profits in doing so—should be discouraged. Persistent breaches

should be a dismissable offence.
The committee should also recognise that there should be effective booking sys-
tems and that they operate satisfactorily even for complex trades.
Credit Risk. By far the major part of the committee’s work will be concerned with
the bank’s every-day business of granting and monitoring credit facilities. The
board will have established the delegated limits and will have approved the frame-
work for processing applications for loans and monitoring them when made.
The committee will:

• Ensure, through management and internal audit, that the system is working sat-
isfactorily; that the board’s procedures for granting or extending loans and
ascertaining borrowers’ creditworthiness have been observed; that discretionary
powers at various levels have not been exceeded; and that the officers and
managers responsible for loans collect and maintain credit information on bor-
rowers. As part of their work, the committee will wish to make sure that applica-
tion for loans are routinely made (at the appropriate level), accompanied by the
most recent financial statements and the previous one plus:
◆ A statement of assets and income to ensure the loan can be serviced.
◆ An assessment of the capacity to repay the loan when due.
◆ The stated purpose of the loan.
• Obtain periodical reports of credit facilities exceeding the stipulated limits.
• Review all large loans and letters of credit in detail and where necessary recom-
mend approval or rejection to the board or the executive committee.
• Ensure that the bank’s directors and officials seek approval for guarantees (or
letters of comfort) as if they were credit facilities and periodically require those
concerned to confirm that the circumstances of parties to whom guarantees (or
letters of comfort) have been given have not materially changed. This is of vital
importance as guarantees do not appear on the face of the accounts, and the
bank may be severely injured by unexpected defaults.
• Ensure that no individual credit facility exceeds the legal-regulatory limits.
Exposure to connected parties must be aggregated and treated as one expo-
sure, whatever the nature of the connection. They must also ensure that they

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are not being misled by customers using the device known as ‘split limits’—in
effect disaggregating borrowings so that each separate deal is within limits, but
together exceed them.
In the course of its operations the committee will want to stress the importance of
personal responsibility. Officials should be encouraged not to evade responsibility
by passing matters upwards unneces-
sarily. It is only too easy to hide behind
Officials should be encouraged not to a committee or someone else’s judg-
ment. If officials need sanction from
evade responsibility by passing matters higher authority, they should always
state their own conclusions—and not
upwards unnecessarily. It is only too mind being overruled.
easy to hide behind a committee. They must also face up to failures.

No one likes to admit that a loan is
going sour, but if it is, the sooner this
is reported the better. Concealment only makes matters worse. This is especially
difficult with related-party transactions, but these like others are better faced
sooner than later.
It is not for audit committees to double-guess this committee on an individual

decision, but it will wish to have reports on cases where the system has failed, for
example. Rules or limits were improperly disregarded.
‘Special’ Committees
Board committees exist to facilitate the thorough and expeditious conduct of busi-
ness. Circumstances may suggest that some subjects could best be tackled by a
committee which included people not on the board, for instance, executives or
outsiders. Such committees need specific terms of reference from the board
which cover their composition, functions, powers (including the right to commis-
sion research and the like), and reporting.

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A N N E X 1 . O P E R AT I O N A L R I S KS
ANNEX 1
It is natural for officials at every level to consider business risk, as it is part and
parcel of their every day work. It is much easier to forget that there are hidden
risks in the sheer process of doing business of any kind, like fire, information
technology (IT) failure, or fraud.
All these types of risk are asymmetrical. None can produce a profit and it is a
matter of avoiding loss. They are inevitable for all banks.
Smaller banks may handle this subject in the executive committee. Larger institu-
tions tend to establish a separate operational risk committee. In either case the
role of the committee dealing with operational risk is to ensure:
• That as part of an operational risk management programme, managers identify
the principal operational risks and take the necessary steps—which may be
acceptance, avoidance, control, or insurance or some combination of these. In
the case of professional liability and lender liability for instance, insurance will
have a part to play, and the committee should ensure that the necessary policies
have been taken out (see annex 4). In the case of fire or the failure of an IT
system, there must be sound business resumption plans to cope with a disas-
ter. The staff must know what the plans are and the part they have to play.
The committee must ensure these plans are tested.
• That the bank’s systems address the financial and reputational risks of money
going astray or being tainted or being misapplied. Into this category fall fraud,
electronic crime, money laundering, improper or unsound or concealed related-
party transactions, and breaches of rules about the concentration of lending
(perhaps by ignoring the “connected party” rules).
The committee will have a central role in safeguarding the bank’s future. It will aim
to ensure that considering risk and controlling it are seen by managers as an
essential part of their task, but they do not become an obsession at the expense
of how best to drive the business forward safely and honorably. Furthermore, over
complex procedures tend to be self-defeating, as formal compliance may mask
concealed dangers. The aim in dealing with risks of all kinds is to get managers at
all levels to factor them into the way they approach business and take the sensible
steps required.
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A N N E X 2 . F R AU D
The nature of the banking business makes it particularly susceptible to fraud.

An international survey in 1993 by KPMG found that 80 percent of frauds were
committed by employees, mainly the misappropriation of cash (and travellers’
cheques). Size does not protect; on the contrary, the bigger the bank, the greater
the risk.
Insiders (employees), outsiders, or a combination of both may perpetrate fraud.

This kind of fraud requires a criminal conspiracy and may be especially damaging.
Directors should bear in mind the need for perpetual vigilance and intelligent
observation at all levels, for these are the essential ingredients whatever rules are
made and whatever systems are employed. Experienced staff often have a sixth
sense that something is wrong and needs investigation; they should follow their
instincts. It is better to find that a transaction was after all legitimate than to miss
ANNEX 2
stopping a fraud. Frauds do not come neatly labeled and packaged, but in all sorts
of clever ways in which the evidence is deliberately fragmented and camouflaged.
Frauds often come at awkward times, for instance on the eve of a holiday or at a
weekend, when there are many distractions and top management is dispersed
and difficult to mobilize. The board should have in place a drill to handle such
emergencies with named participants and reserves if some are unavailable. In
practical terms this means the bank having at all times a duty officer who has the
contact numbers for the named people.
The suspicion and confirmation of fraud is highly disagreeable (quite apart from the
pecuniary consequences) because it so often implicates officials of the bank who
have hitherto received colleagues’ trust. Sometimes it will transpire that they had
been subject to severe financial strain; occasionally they may have been blackmailed;
they may simply have been greedy or impatient; or just bored and susceptible to
suggestions from or coercion by a third party inside or outside. They may defraud
to support a cause in which they passionately believe—even terrorist activity.
None of these is an excuse for criminal activity. Frauds are just as likely to be
committed by new employees who may feel they have little to lose, as by trusted
long-standing employees who have access to a bank’s most secure places.
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Finally, the directors may have great confidence in the systems the bank oper-
ates—and this confidence may be based on the absence of significant fraud for
years. All the more reason to look diligently at measures of prevention and get
objective and periodical reports on vulnerability.
Prevention
Prevention is better than cure; getting the money back is usually difficult.
The directors should ensure that staff work in ways designed to reduce the risk of
fraud by requiring:
• Care at the point of recruitment. This includes getting sound references from
trustworthy people and being certain that nothing in the applicant’s background
could put him under pressure or infer untrustworthiness. There should also be a
credit check.
ANNEX 2
• That staff at every level, including directors, take two consecutive weeks holiday
away from the bank every year.
• The separation of functions. Dealers for instance should never settle their own
transactions. The front office should always be separate from the back office.
• The ‘four eye’ rule. Certain transactions should always require the participation
of two people.
• That traders dealing in different time zones, sometimes from home or elsewhere
off premises on mobile phones, should keep adequate records. There should be
independent confirmation of trades by the parties’ back offices. Such business
is an inevitable consequence of globalization.
• That there are special measures to cope with the risks posed by IT:
◆ Ensure there are written standards governing access to and the use of com-
puters to protect them from improper use or unauthorized access (however
innocent). This includes restricting physical access to the area in which the
computer is installed. The standard should also cover the operation of a
secure library including access to it.
◆ Ensure the system provides a full audit trail. This includes recording the tele-
phone numbers of access calls (and where possible restricting access to
specified telephone numbers). It should also cover records like magnetic disks
and tape and floppy disks.
◆ Require management periodically to check that standards are being met and
are effective.
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Discovery
Directors need to satisfy themselves that all the bank’s staff are alert to the possi-
bility of fraud by encouraging and rewarding those who successfully prevent it or
display special acumen in identifying it. (Examples could be complex—or simple,
like forging the contents of cheque by altering the payee or amount or both.
Forgery has become a fine art. A bank can now use highly sophisticated means of
detection, but the forger too has technology on his side.) Directors need to ensure
that employees are up to date in their procedures for checking and authenticating
documents and that they have the latest technology at their fingertips and know
how to use it.
Directors also need to provide for the difficulty in which an employee finds himself
when it is the action of a colleague or superior in the course of work that arouses
his suspicions. There may also be something outside—for instance, a sudden and
ANNEX 2
unexpected change in someone’s lifestyle. He needs to be able to discuss his

concern (which in the end may prove groundless) with a trusted senior member of
staff, quite possibly a director, who will not betray him. Directors should consider
nominating such a person and telling all employees about confidential access to him.
In the normal course of business many mistakes and irregularities occur, and most
when examined prove innocent and are rapidly remedied. Even when there is a
suspicion that the irregularity is not innocent and that fraud may be a possibility a
manager may be reluctant to treat it as such. He may fear that he will look foolish
if it transpires there is no fraud and incompetent if there is. He may be reluctant to
point the finger of suspicion at a colleague. Or he may simply not believe the evi-
dence paradoxically if the sums are very great. A good maxim is, ‘When in doubt
suss it out’.
There should be a procedure in place to enable managers to obtain advice and

assistance from in-house accountants (or other professional help) in interpreting
the facts and transactions that have given rise to suspicions. With such a policy
in place, false alarms should be treated graciously as evidence of vigilance and
conscientiousness.
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Remedial Action
Directors have several objectives when fraud is confirmed:

• To stop it.
• To take remedial action to repair the damage.
• To prevent its happening again.
• To remove the perpetrators (if they are employees).
• To assist in the prosecution of the criminals.
First steps:
• Put a senior manager in charge of the case. (This provides the necessary
authority for instructions and also the contacts with top management.)
• Preserve the evidence, documentary and computer-based. (This may mean
impounding laptops to prevent their being cleaned.)
• Take remedial action to change procedures and systems that have proved vul-
ANNEX 2
nerable (and inform the audit committee).
• Organize the investigating team. Familiarity with the bank’s structure, proce-
dures, and personalities is an asset. Internal audit may have an important contri-
bution to make. Some questioning at this stage is inevitable, but it should be
conducted by a senior manager accompanied by an observant and responsible
colleague and carefully recorded (time, place, duration, and content of interview).
• Inform the regulator of any significant fraud.
The Police
At the right moment the police (in the UK, the National Criminal Intelligence
Service, or NCIS, or where appropriate the police) should be informed. The timing
is a matter of judgment after the preliminary investigation reveals that the existence
of a fraud is certain or highly probable.
At this point the questioning of suspects is best left to the authorities who will wish
to determine the facts, preserve the evidence (for trial later), and locate stolen funds.
It may be however that the authorities have become aware before the manage-
ment of the bank that a fraud was planned or already under way. They may refrain
from action in order to catch the criminals red-handed and obtain the evidence to
secure a conviction. Whilst this is legitimate, the authorities should take account of
the bank’s commercial imperatives—safeguarding its assets and removing as
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quickly as possible employees who threaten them—and do all in their power to

minimize the potential loss to the bank without jeopardizing their chance of secur-
ing a conviction. This is an area of great sensitivity and calls for tact, trust, and
cooperation between the bank and the authorities as their interests are not identi-
cal. If the authorities become too heavy-handed, they reduce the probability of
matters being reported to them in future that look in any way doubtful. A bank
may be put in vulnerable position if the authorities wish it to freeze money in a
‘dubious’ account but at the same time insist that they do not alert the client to
the fact they are under suspicion. Quite apart from the fact that this may open the
bank to suit for damages, the mere act of refusing to pay money out itself sends a
signal. This is an area which requires further legal clarification.
Mistakes
Much money is lost every year by mistakes, such as funds being transferred to the
ANNEX 2
wrong accounts or errors in booking. Such losses cannot be insured, so the

imperative is to avoid making them, and identifying them and reporting them as
soon as possible if they do occur. The longer the delay in doing so, the greater the
danger that the loss cannot be avoided or mitigated.
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A N N E X 3 . M O N E Y L AU N D E R I N G
Money obtained from crime is tainted and subject to confiscation by the authori-
ties. ‘Crime’ includes terrorism, extortion, blackmail, theft, tax evasion, and drug
offences. To avoid this risk, its owners ‘launder’ it by passing it through financial
and business institutions in such a way that it appears ‘clean’.
Serious laundering is conducted by organized crime which stops at nothing to

attain its ends and uses coercion and bribery as means of doing so. It can afford
the best brains to circumvent IT systems and is adept at finding original solutions
when its way is blocked. Laundering is increasing to epidemic proportions. It can
ruin the reputation of banks who are found to be a soft touch. It threatens legiti-
mate enterprises—and whole communities, even states. So grave is the threat that
the G10 countries formed a Financial Action Task Force (FATF) to counter it. It has
issued 40 recommendations.
Money laundering is a business risk—and preventing it is not merely a matter of

legal compliance. It is not enough to meet the technical requirements of local rules
(which may not be very tough). Rather, bank directors should assess the bank’s
exposure to money laundering, just as they do any other identifyable risk, and the
impact it would have on business and calibrate their response to it accordingly,
independently of the legal requirements.
In addition, the directors should acquaint themselves with the main provisions of
any relevant money laundering regulations (in the UK, the Money Laundering
Regulations of 1993) but also be aware that changes are or may be on the way.
The regulator may require a bank to appoint a senior officer with special responsi-
bility to report money laundering. In the UK the post is called money laundering
ANNEX 3
reporting officer (MLRO). Depending on the size and organization, a MLRO may be
a member of a section housed within the internal audit unit or with other control
units or it may operate separately. In a big bank a MLRO will have subordinates.
Wherever located, he is the bank’s focal point in the combat against laundering.
The directors should know who he is and satisfy themselves he has effective
reporting lines.
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The responsibilities of a MLRO are:

• To understand what the official requirements are, and to familiarize himself with
the subject and the latest developments. If in doubt he should seek advice from
the regulatory authority (in the UK, the FSA or if appropriate the NCIS).
• To make sure that management has prepared and promulgated policies which
reflect official advice and that the relevant staff have received training in identify-
ing dubious transactions and deposits. They will have been made aware that
money laundering is usually a three-stage operation:
◆ Placement—putting the funds into the system.
◆ ‘Layering’—the use of a series of apparently normal transactions to disguise
the original source of the funds.
◆ Integration—mixing the tainted funds with clean money so it becomes difficult
to distinguish them.
He (and his staff) will have been shown how to use the relevant computer pro-
grammes that identify transactions that are unlike the usual pattern for that client and
others that draw attention to disaggregated transactions. It is a common launderers’
practice to divide their funds into relatively small sums so as to escape notice.
Staff should be trained to recognize suspicious deposits and instructed in the drill
for reporting them. Speed is of the essence. Tainted money does not linger. They
must feel totally confident that blame will not attach to them if a dubious transaction
turned out to be legitimate after all. They must also be trained to act circumspectly
so as not to arouse the suspicion of the ‘dubious’ party. A suspicious deposit
should be reported (in the UK, to the NCIS) and the money in it frozen until released
by (the NCIS or) the police. It cannot be stressed enough that account opening
procedures are crucial. As a general rule the official should meet the depositor face
ANNEX 3
to face. This is one aspect of the basic rule—KNOW YOUR CUSTOMER.
There is a great temptation to accept deposits coming out of the blue without
enquiring too closely where the funds originated. This is unacceptable. The bank
official concerned should check the provenance of the funds concerned and
watch out for changes from the initial pattern—like depositing millions after some
modest beginnings to the account.
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All this requires judgment. The bank does not wish to deter legitimate business.
The task therefore is to conduct affairs so that sensitive enquiries illumine suspi-
cious circumstances without upsetting the honest.
• To liaise with the auditors about the adequacy of the bank’s arrangements in the
light of periodic checks. Of course if the auditors encounter suspicious circum-
stances in the course of their work, they should notify the bank’s management
at once.
• To liaise with the bank’s IT specialists about systems design so as to incorporate

wherever possible programmes to counter laundering.
• To liaise with management about rewards for employees who are especially dili-
gent in the identification and reporting of money laundering, and penalties for
those who are negligent or criminal.
ANNEX 3
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ANNEX 4. INSURANCE
ANNEX 4
Directors are of course aware of insurance as part of their ordinary lives. They may
be less aware of the large part it can play in mitigating the effects of risk in a bank.
Some of the main uses are listed below. Identifying the need for insurance and
arranging cover are among the duties of the risk management committee as noted
above. Personal liability cover for the directors however is a matter for the board itself.
Insurance is itself costly; not all risks can be readily insured anyway—for example,
booking errors, transfers to wrong accounts, failure to post a transaction correctly,
unauthorized trading. Some risks are uninsurable. There is, in other words, no
substitute for sound systems, care, diligence, and rapid reporting which leads to
prompt remedial action.
Standard Risks
It goes without saying that a bank will want to cover itself for standard risks like
fire, robbery, cash in transit, and so forth. An area that merits particular attention is
IT in all its many aspects. These and several other categories like consequential
loss should be regularly reviewed by management to make sure cover is adequate
and that rates are competitive. Decisions to carry one’s own risk should be endorsed
by the risk management committee and if material enough by the board itself.
Personal Liability
This concerns the liability of directors and officers and not the bank itself. It is dealt
with by directors’ and officers’ insurance (D&O) and covers their alleged negligent
acts and omissions. The bank pays the premiums and indemnifies the directors
and officers; where this is not possible for regulatory, financial, or legal reasons,
insurers indemnify the directors and officers direct. This kind of cover is important
as its absence might deter outsiders joining the board since all their personal
assets might be at risk. The standards of care and knowledge expected of nonex-
ecutive directors are rising and so is the range of responsibility they now bear.
Consequently they are more at risk and premiums have risen.
One growing source of D&O liability is employment actions, especially, but not
exclusively after mergers and acquisitions. Another is environmental claims where
the trend is for the law to make directors personally liable.
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Professional Indemnity
ANNEX 4
This policy is designed to protect the bank itself against litigation alleging damage
through the bank’s negligence, errors, omissions, and misstatements, made by
employees. The scope of the cover will be set out in the contract, and it is essential
to know what it is as there may be significant exclusions. Typical areas for cover
might be advisory services (a growing segment), custodian relationships, trust, or
brokerage. Care should be taken to ensure that the policy is appropriate for the
jurisdiction and legal system in which the activity takes place. Especial care should
be taken to ensure that operations in foreign countries are adequately covered by
insurance for the risks there, bearing in mind the laws, business practices, political
and social conditions, and propensity to litigate in that particular market.
Lender Liability
Such cases are rare though occasionally a bank faces a claim for breach of con-
tract or negligence.
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A N N E X 5 . AC C O U N T I N G A N D AU D I T I N G
S TA N DA R D S
The freer flow of capital in recent years has greatly increased cross-border invest-
ment. This in turn has put pressure on the regulatory authorities and the account-
ing profession to move towards greater uniformity of accounting standards, a
common language so to speak, so that users of accounts know that common
conventions apply and that sets of accounts do not have to be reinterpreted
according to the country of origin. This is a slow business, however, as some of
the differences are substantial and are linked to differences in the tax regimes and
beyond that to the national psyche. Hiding reserves, for instance, is much more
prevalent in some countries than others, and the laws reflect this.
As this process is a slow one, directors in all jurisdictions should hold fast to the
principle that the accounts should not only comply with the law but also give an
ANNEX 5
honest and accurate account picture of the bank’s position and performance.
The directors of banks throughout the world need to be aware of the general ten-
dency towards uniformity (however slow progress is) and to make sure their audi-
tors keep them abreast of developments and the way it will affect them.
The same tendency is observable with regard to auditing standards and the same
caveats apply.
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A N N E X 6 . A N E T H I C S S TAT E M E N T
Directors may wish to issue a simple statement on ethical policy to the bank’s
staff. The following might be adapted to the bank’s particular needs.
General
Our policies, products, and behaviour conform in spirit as well as in law to the
highest moral principles.
Our Approach
We approach all our relationships on the basis that they will be long term. This
means that we conduct them honestly and scrupulously. We do not take advan-
tage. We do not deceive. What we say we will do, we do. If we are prevented, we
say so as soon as we know. We know that business depends on trust. We do all
we can to earn it and nothing to impair it. The quality we aim at in all our dealings
is integrity.
The Bank
We all depend on the bank. We try to protect and enhance its name and reputa-
tion and we do not act in ways that would bring discredit on it. We keep its
secrets secret. If we are faced with a conflict of interest, we declare it. We look
after its assets as if they were our own.
Colleagues
ANNEX 6
We do all we can to ensure that colleagues are treated properly and given every
chance the bank can offer to realise their full potential. We work within a team and
do all we can to support other members of that team and of other teams in the
bank. We do not let personal ambition drive us into behaviour of which we would
be ashamed if it were known. If we are leaders at any level, we set an example
knowing that what we do and refrain from doing are as important as what we say.
51
17553_GCGF 10/17/03 5:27 PM Page 52
The Community
We observe the laws and regulations to the letter in our own country and in any
country in which we do business. We respect the local community in which we
work and try to add to its coherence. We have regard for and respect the environ-
ment. We encourage colleagues to play their part in the community.
Customers
Whatever others do, we do not bribe to obtain or keep business.
If we pay commissions they must appear on the face of the documents. We look
after customers as if they were there forever; we compete for their business as if
they would leave tomorrow. We do not accept bribes. We keep their secrets (with-
in the limits of the law). Our services meet our description and all relevant stan-
dards. We know that the bank’s position in highly competitive markets means we
must deliver value and service. These can always be improved and that depends
on our making whatever personal contribution we can.
Shareholders
We remember their interests and try to protect them. We do not waste their assets
or give them away without their permission. We keep them accurately informed.
The accounts we present to them are reliable, truthful, accurate, and complete.
We try to paint as clear a picture as possible of the bank’s position and prospects.
There are no ‘off books’ transactions.
Whenever we are in doubt about an action, we test it by asking ourselves whether

ANNEX 6
we would like it to be brought to public attention and be an object of comment.

Would we like to see it reported in the press?
52
17553_GCGF 10/17/03 5:27 PM Page C
Project Officer:
Alyssa Machold,
Global Corporate Governance Forum
Editor:
Nancy Morrison, Falls Church, VA
Graphic design:
Studio Grafik, Herndon, VA
Printer:
Upstate Litho, Rochester, NY
17553_GCGF 10/17/03 5:27 PM Page D
Co-founded by the World Bank

and the Organisation for Economic
Co-operation and Development
(OECD), the Global Corporate
Governance Forum is an advocate,
a supporter, and a disseminator of
high standards and practices of
corporate governance worldwide,
especially in developing countries
and transition economies. Through
its co-founders and other donors,
including the governments of India,
Luxembourg, the Netherlands,
Norway, Sweden, Switzerland, the
United Kingdom, and the United
States, the Forum brings together
developed and developing countries.
Global
Corporate
Governance
Forum
1818 H Street NW
Washington, DC 20433 USA
Telephone:
+1 202-458-1857
Facsimile:
+1 202-522-7588
Internet:
www.gcgf.org
Email:
cgsecretariat@worldbank.org
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17553_GCGF 10/20/03 4:45 PM Page A

He is the author of Keeping Good Company, a comparative study of the United

Guidance for the Directors of Banks

Jonathan Charkham CBE

Global Corporate Governance Forum

Copyright 2003. For permission to photocopy or reprint,

The material in this work is protected by

ii Guidance for the Directors of Banks

Annex 1. Operational Risks................................................................................39

Guidance for the Directors of Banks

iv Guidance for the Directors of Banks

In discharging their oversight responsibilities, bank directors often find it essential

In developing and transition countries, there cannot be sustainable economic

Guidance for the Directors of Banks v

vi Guidance for the Directors of Banks

Guidance for the Directors of Banks vii

viii Guidance for the Directors of Banks

Strategy —Strategy is the design of longer-term policies to pursue the bank’s

Guidance for the Directors of Banks 1

Corporate governance —Corporate governance is the system by which banks

Risk management —Risk management is the systematic process for identifying

These principles mean that there is no such thing as a representative director,

2 Guidance for the Directors of Banks

Connected parties —The issue of connected parties may be important in many

Capital adequacy and the risk-asset ratio —Capital adequacy is the

Guidance for the Directors of Banks 3

Globalization —Globalization has many dimensions. It may refer to:

Independence means their being independent of management—objective in their

4 Guidance for the Directors of Banks

Independence is an attitude of mind and an attribute of character. Apart from the

Independence means not yielding to threats or blandishment, but forming a view

Guidance for the Directors of Banks 5

6 Guidance for the Directors of Banks

The emphasis of corporate governance developments has throughout mainly been

Guidance for the Directors of Banks 7

The economic benefits of good

transparency. Underlying them all is Several themes are reflected in the

There is an identity of interest

8 Guidance for the Directors of Banks

The Legal Form

The framework of the limited liability company is designed to:

• Facilitate the aggregation of capital. Companies are an effective way of mobilizing

• Create the possibility of “corporate immortality”. Unlike partnerships and several

Guidance for the Directors of Banks 9

• Their importance at the centre of every country’s financial commercial and

The Division of Company Functions

10 Guidance for the Directors of Banks

designed to mitigate some of these effects but a dominant founding father of a

There is another dimension to accountability in respect of what are sometimes

Guidance for the Directors of Banks 11

12 Guidance for the Directors of Banks

4. THE STRUCTURE AND COMPOSITION OF THE BOARD

and nonexecutive directors. Where there is a separate chairman, he and the

‘Independence’ is defined in the glossary above. Independent directors must be

Guidance for the Directors of Banks 13

An ideal board will include members with a wide

14 Guidance for the Directors of Banks

As directors cannot do everything themselves and must delegate, they must

Guidance for the Directors of Banks 15