The legal rules or ownership policy must establish checks and balances in the way the government exercises its ownership role, generally by sharing the responsibility between different departments. In this process, care should be taken to avoid a regulatory ‘overburden’ (Reddy, 2006): if state owned institutions are overseen by a range of entities with different requirements, such as the treasury, a line ministry, the legislative assembly, the auditor general or even special commissions, they face a heavy reporting burden or, worse, conflicting instructions.
ii State as supervisor
The counterpart of the ownership entity is the supervisory entity, which should be separate and independent from the ownership function. Fletcher and Kupiec (2004) apply the Basel principles for banking supervision (BCBS, 2006) to state-owned financial institutions. They suggest the establishment of an independent supervisory capacity, which can protect the state against both credit and reputational risk, while also protecting the private sector from unfair competition from state-owned financial institutions. Their preconditions for successful supervision are sustainable macroeconomic policies, a well-developed legal system, a robust accounting profession and a strong and independent supervisor. The authorising legislation of the state-owned financial institution should set the mission of the organisation; the method of funding, government capital and/or subsidies; prudential standards and accounting and auditing requirements; specific standards for operations, where required; and performance criteria and the method of assessment. To be effective, the supervisor should have operational independence, sufficient resources, an appropriate legal framework and enforcement capacity, and adequate information-sharing arrangements. They see the role of the supervisor as setting criteria for activities, monitoring operations, evaluating activities in line with the mandate, and instituting corrective measures if required. The supervisor also has to do the following:
Capital adequacy: Define regulatory capital and set capital adequacy requirements
. Evaluations: Ensure independent evaluations of policies and operations, independent internal and external audit and compliance, formal plans with clear responsibility for internal oversight, and appropriate internal separation of duties to avoid conflicts of interest.
Transparency: Ensure adequate financial policies, practices and procedures; the use of appropriate record keeping and accepted accounting policies; regular publication of audited financial statements; and the use of separate accounts for commercial and developmental operations, with the former being subject to the Basel II principles.
Fletcher and Kupiec (2004) argue that the bulk of the supervision and regulation should be along the same lines as the private sector. But should state-owned development finance institutions be subject to the same rules as the private sector? On the one hand, they pose more regulatory challenges than do private firms: for the state, the conflict of interest noted above, and for the institution, the problems of political interference, weak management capacity, and the state’s poor regulatory capacity. On the other hand, given that they operate in underserved markets and under difficult conditions, overregulation may be counterproductive as it could inhibit innovation and risk-taking. Thus, the International Monetary Fund and the World Bank (2003) call for regulation of specialised financial institutions that has ‘a sufficiently light touch so as not to crush them’
Risk management: Ensure a comprehensive risk management process for all material risks and appropriate risk-modelling techniques for interest rate, credit, market, currency and operational risk, for example.
Conduct on-site supervision and independent verification of governance procedures and information accuracy, as well as off-site monitoring of the financial situation based on prudential reports.
Obligate institutions to publish annual reports on safety or soundness issues and take remedial action when institutions fail to meet requirements. There is a need for a mechanism to ensure that the supervisor’s recommendations are implemented, and a need for the supervisor to have appropriate legal authority. Fletcher and Kupiec (2004) argue that the bulk of the supervision and regulation should be along the same lines as the private sector. But should state-owned development finance institutions be subject to the same rules as the private sector? On the one hand, they pose more regulatory challenges than do private firms: for the state, the conflict of interest noted above, and for the institution, the problems of political interference, weak management capacity, and the state’s poor regulatory capacity. On the other hand, given that they operate in underserved markets and under difficult conditions, overregulation may be counterproductive as it could inhibit innovation and risk-taking. Thus, the International Monetary Fund and the World Bank (2003:4) call for regulation of specialised financial institutions that has ‘a sufficiently light touch so as not to crush them’
- Disclosure and transparency are key aspects of governance involving: (i) efficient internal audit procedures and audit function monitored by the Board and the audit committee; (ii) an annual independent external audit based on international standards—i.e. the same high quality accounting and auditing standards as listed companies; and (iii) disclosure of financial and non-financial information according to high quality internationally-recognized standards.
Good corporate governance practices are paramount for survival and sustainability of development banks both in developed and developing economies. The most effective way to control potential weaknesses and prevent abuses is to put in place measures aimed at strengthening the governance arrangements around Board and Management, including: (i) a formal, merit-based, transparent process for appointing independent directors to the Board, as well as performance-based assessment and salaries of DFI Management; (ii) a majority of the Board to be comprised of independent, highly qualified, professional and experienced directors who are competitively selected; (iii) encouraging minority shareholder representation and reputable international investors’ participation on the Board of the DFI; and (iv) competitive selection and appointment of key executives (including the CEO) by the Board with the participation, to the extent possible, of all shareholders. Good corporate governance is as important for state-owned institutions as for private sector institutions and can contribute to improve their performance. Given their public policy role, it is all the more important that development finance institutions have a proper framework in place to ensure that they carry out their mandate and meet their objectives effectively.
According to the OECD (2004), corporate governance refers to “a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring”. Evidence suggests that most of the poor performance of DFIs is explained by shortcomings in corporate governance structures, which are instrumental to political interference and poor managerial skills (Dinc, 2005; Caprio et al, 2004; La Porta et al, 2002). Yet putting in place a proper governance system in place for DFIs is not an easy task. This is because the exercise of direction and control is complicated by the multitude of institutions usually involved in the ownership of a DFI. Moreover, given the leverage involved in their operations, DFIs have the potential to create contingent fiscal liabilities for the government. Finally, DFIs have to balance a trade-off between the two potentially conflicting objectives of fulfilling their policy mandate and being financially sustainable (Scott, 2007). For all these reasons, introducing and enforcing a sound corporate governance system requires a significant investment in resources and, most importantly continued commitment by the shareholders.
- A case for successful framework for development bank in Ghana
In Ghana, development bank has been established and funded by the Government with financial support from the German KFW and World Bank to develop and promote certain strategic sectors of the economy, and to achieve social goals. The important sectors of the economy will be supported by the development bank is to promote industrialisation, particularly the export-oriented industries, infrastructure development and highly capital-intensive investments and the agriculture sector. The development bank also intended play a crucial role in the development of SMEs and agriculture sectors.
The development bank is expected primarily to fill in the gaps in the supply of financial services that are not normally provided by the banking institutions. Such development institutions are generally specialised in provision of medium and long-term financing of projects, which require specialised skills and focus, and may carry higher credit risks or market risks due to the longer investment tenures. In some cases, the mandated roles of the development bank include the promotion and achievement of Government’s specific social and economic objectives. From theoretical literature perspective, good corporate governance practices, fit and proper person test criteria, clarity of mandate, stable macro-economic environment, strong and robust risk management practices, financial sustainability for commercial role, robust regulatory and supervisory framework, and performance contract arrangement would contribute significantly to the success of the Ghanaian development bank. Studies from other jurisdictions some development banks that used the above framework have succeeded in stimulating development, especially in countries such as India, Brazil and South Africa, and are poised to play a growing role in the development of these economies.