Emmanuel Tumusiime-Mutebile: Corporate governance and banking
regulation in Uganda
Address by Mr Emmanuel Tumusiime-Mutebile, Governor of the Bank of Uganda, to the KCB
Bank of Board of Directors Retreat, Kampala, 2 November 2012.
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1. Introduction
Good corporate governance has become increasingly recognised worldwide as essential for
the efficient functioning of market economies and to ensure that they function in the interests
of the wider society, and not just those with power and wealth. The focus of corporate
governance is the manner in which the business and operation of a firm is governed by its
board of directors and senior management.
At the core of corporate governance is the relationship between what are often termed the
"insiders" of firms - dominant shareholders and senior managers - and the "outsiders" who
include small shareholders, the creditors of the firm, its employees and customers and the
general public. A key objective of corporate governance is to ensure that the insiders who
control the management of a firm do not abuse their control and act in a manner which is
detrimental to the interests of outsiders.
Good corporate governance is even more important for banks than it is for non financial
firms, for two key reasons. The first is the much greater inherent opacity of the balance sheet
of banks; it is difficult for outsiders to evaluate the quality of the assets which a bank holds
and, therefore, its true financial position. Secondly, the potential negative externalities of
bank failures are very damaging for the economy and for society, as was demonstrated
vividly by the global financial crisis.
Corporate governance in banking has certain features which distinguish it from corporate
governance in non financial firms. This is because of the unique characteristics of banks, in
particular the fact they are very heavily leveraged and that most of their liabilities are owed to
a large number of atomised depositors who have the most to lose from abusive or negligent
management. Consequently, a priority of corporate governance in banking is the protection
of the interests of depositors. In addition, the corporate governance of banks attaches
particular importance to the veracity of financial information.
2. Bank failures in Uganda and the reform of bank regulation
In the 1990s and early 2000s, Uganda's banking industry suffered a number of bank failures.
Eight banks failed, forcing the Bank of Uganda (BOU) to intervene and resolve them; in some
cases the failed banks were closed, in others they were sold to new owners. The primary
cause of most of these bank failures was poor corporate governance. In many of the failed
banks, a dominant shareholder or group of shareholders was able to exert undue influence
over the management of the bank which resulted in abuses such as pervasive insider
lending. The losses incurred on insider loans were the single most important contributor to
the collapse of these banks. The Kenyan banking industry was also afflicted by multiple bank
failures in the 1990s, with poor corporate governance playing a major role in these failures as
it did in Uganda. Poor and abusive management was allowed to flourish in banks because
their boards of directors were usually weak, lacking the professional expertise and often the
independence and incentives to provide any effective oversight of bank management.
The bank failures of the 1990s prompted the BOU and the Government to strengthen
banking regulation. Parliament enacted new legislation in 2004 - the Financial Institutions
Act - which, inter alia, raised minimum bank capital requirements, tightened restrictions on
insider lending and mandated the BOU to intervene promptly in failing banks before their
capital is completely eroded and their depositors suffer losses. The FIA also imposes a
ceiling of 49 percent on the share of a bank's equity which a single shareholder, or a group of
related shareholders, can hold, in order to limit the influence of dominant shareholders,
although this ceiling does not apply to shareholdings by reputable parent banks domiciled in
other jurisdictions with good home country bank regulation.
But we also recognised that statutory bank regulation and supervision by a public agency
cannot be expected, on its own, to guarantee the sound management of banks. Moreover,
excessively heavy handed regulation, although it might protect depositors, can also stifle
innovation and risk taking in banks, which would be detrimental to economic development. In
a market economy, the onus for sound management, including the proper management of
risks, must lie with the banks themselves. Bank regulators cannot be a substitute for bad
bank managers. As such good corporate governance is an essential complement to good
bank regulation and supervision.
This principle was made explicit in the Financial Institutions Act, section VII of which was
devoted specifically to providing a regulatory framework for good corporate governance in
financial institutions. The provisions in section VII of the FIA were supplemented by a set of
corporate governance regulations which were issued by the BOU in 2005. Uganda's
corporate governance regulations were influenced by the guidelines published by the Basel
Committee on Banking Supervision, based at the Bank for International Settlements, which is
responsible for formulating global standards for bank regulation and governance.
The corporate governance regulations in Uganda focus on four key themes:
i) The fiduciary responsibilities of the Board of Directors;
ii) The importance of independent oversight of bank management;
iii) The priority which must be attached to risk management; and
iv) The need for independent audit functions.
I would like to elaborate briefly on each of these themes.
3. The role of the Board of Directors
Our corporate governance regulations place great emphasis on the fiduciary responsibilities
which the Board of Directors owes to the bank, its depositors and shareholders and to the
wider society. The Board collectively must take ultimate responsibility for the performance of
the bank and for the manner in which it conducts its operations. The directors must lead from
the top. They must set the strategic policies of the bank and establish its corporate values.
They must also ensure that a bank's policies prohibit corruption and conflicts of interest in the
bank's operations. An important function of the Board is to define clearly the duties and
responsibilities of each member of the bank's senior management.
To exercise their responsibilities, the directors themselves must be of the highest integrity
and have the professional expertise necessary to understand the nature of a banking
operation and, in particular, how it differs from that of a non bank company, and what that
means for the fiduciary responsibilities of the directors. Our regulations also stress that an
individual director cannot hide behind collective board responsibility. Each director can be
held individually responsible for any failings of the bank. He or she has a responsibility to
report in writing to the bank regulator - the Bank of Uganda - if he or she has any reason to
doubt that the bank may not be able to meet all of its obligations to its creditors or may not be
able to operate as a going concern in the future.
4. Independent oversight of bank management
Uganda's corporate governance regulations stipulate a clear demarcation of responsibilities
between the Board of Directors and the bank management. This is a very important principle.
The Board must be able to exercise oversight of bank management and hold it to account,
which will only be possible if most of the directors are independent of the bank management.
This principle is often violated in the corporate world in this region, where the distinction
between the respective responsibilities of directors and management is sometimes poorly
understood. To ensure that the Board can be independent, our corporate governance
regulations stipulate that at least half of the directors of a bank, including the Chairperson of
the Board, must be non executive directors. The non executive directors should not
participate in any way in the day to day running of the bank.
5. Risk management
The Board of Directors must take the lead in formulating effective risk management policies
and procedures and in monitoring their implementation by the bank's management. In
particular the Board must ensure the bank has adequate capital, in terms of both its
magnitude and quality, to maintain the safe operation of the bank.
The corporate governance regulations require Boards of Directors to establish two Board
sub-committees for purposes of risk management; a Risk Management Committee and an
Asset Liability Management Committee. The former is responsible for the general oversight
of risk management in the bank, while the latter is responsible for setting specific guidelines
to manage risk, such as single loan exposure limits and loan to capital ratios. The guidelines
set by the Board or its sub committees must, of course, be consistent with the regulations in
the FIA where applicable. For example, the Board may approve policies which would raise
the bank's capital above the minimum statutory capital requirements, but it cannot set capital
requirements which are lower than the statutory minimum.
6. Audit function
Uganda's banking regulations emphasise the importance of the role played by independent
internal and external auditors in ensuring good corporate governance, and in particular
ensuring that the bank's financial statements accurately and fairly reflect the its true financial
position. Each bank must have an internal auditor who is independent of the bank
management and who reports to the audit committee of the Board. The duties of the internal
auditor including evaluating the accuracy of financial information prepared by the bank's
accounting and computer systems and monitoring management's compliance with the
policies and procedures of the bank.
Boards of Directors must use the internal and external auditors as an independent check
on the information that is provided by the management of the bank. I want to stress that
the Board of Directors must approve the audited financial statements of the bank, before
they are published; hence the Directors must have complete confidence in the
competence and independence of the auditors who have prepared the financial
statements.
7. Conclusions
Banks perform a unique role in a modern market oriented economy. When banks work
well they contribute to economic growth by allocating scarce financial resources
efficiently and allowing private companies and individuals to undertake productive
investments which they could not fund fully from their own resources. When banks work
badly, which is not uncommon, the damage is often felt throughout the economy; by
depositors, firms who need credit and taxpayers. The unique nature of banks provides
the rationale for prudential regulation. But it is unrealistic to expect that bank regulation
alone can guarantee the efficient and safe operations of the banking system. Good
corporate governance is as equally important for sound and efficient bank management
as bank regulation. Corporate governance must start with the Board of Directors, setting
the overall strategic policies of the bank and providing independent oversight of bank
management. In particular, the directors must understand clearly their fiduciary
responsibilities. They must ensure that the bank's risk management is adequate to
ensure its safe operation, so that depositors funds are protected and that the financial
statements provided by the bank to the regulator and the public are accurate.