The Imperative of Strong Corporate Governance for Financial Stability
Address by Dr. Alvin Hilaire, Governor of the Central Bank of Trinidad and Tobago
Launch of Financial Stability Report June 13, 2017
1.
The global financial crisis of 2007/09 brought into sharp relief the dangers that weak
governance in financial institutions can pose for economic stability. It is well known that a
major catalyst for the crisis in late 2007 was the subprime mortgage market debacle that rapidly
spilled over into more general liquidity and eventual solvency problems in the United States. The
contagion effects were virtually instantaneous and quite dramatic-moving from mortgage
lenders in the US to other financial firms and then quickly spreading across the globe to usher in
a full blown global economic downturn. As intriguing and intertwined as they were, the purely
economic and financial components behind the nuclear bomb-type mushrooming of the
situation-overleveraging, closely interlinked capital markets etc.-were just part of the
problem. It quickly became apparent to most observers that weaknesses in governance of
financial institutions played a significant part in actively encouraging or at minimum facilitating
behaviors that turned out to be destabilizing. Some analysts held the view that the governance
framework-including the laws, codes of conduct, regulation and supervision-was deficient
and needed to be substantially beefed up; another school of thought posited that the apparatus
itself was basically sound but implementation of established principles was deficient. However
one cuts it, the consequences of the financial crisis were vast in terms of lost output,
unemployment, financial instability, and bailout costs to taxpayers across the world, and
meaningful efforts were subsequently devoted to explicitly strengthening financial sector
governance.
2. At the company level, incentive systems can foster practices that progressively sow the
seeds for failure unless there is consistent and diligent oversight by Boards, shareholders and
Broadly speaking, corporate governance refers to "a set of relationships between a
depositors.
company's management, its board, its shareholders, and other stakeholders...The presence of an
effective corporate governance system, within an individual company or group and across an
economy as a whole, helps to provide a degree of confidence that is necessary for the proper
functioning of a market economy."1 For financial institutions in particular, a solid "set of
relationships" is crucial given the pervasive role that these institutions play in all facets of an
economy and people's lives. Also to be taken into account is the growing complication of
financial transactions in a climate where technology allows for rapid movements of funds, while
abrupt changes in market sentiment can lead to large scale deposit runs. Public trust and
confidence are therefore essential and good corporate governance helps to set a basis for that
assurance.
3.
The international experience over the last few years has led to major advances in
strengthening the governance framework for financial institutions. The magnitude and reach
of the global financial crisis prompted a great deal of soul searching and introspection on the part
of governments and regulators as to what went wrong and how to forestall similar meltdowns in
the future. In zeroing in on the potential governance fragilities that were unearthed, major
legislative changes were enacted; regulation and supervision were reinforced and backstopped by
more substantial penalties for violations; and collaboration among regulators was significantly
enhanced at domestic and international levels. By way of example, in the US the Dodd-Frank
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) was passed in 2010 to,
among other things: i) address risks to the stability of the US financial system in part via the
creation of the Financial Stability Oversight Council; ii) end too-big-to-fail bailouts of large,
complex financial institutions; iii) increase transparency and regulation for certain complex
financial instruments; and iv) strengthen protections for consumers and investors.2 More
generally, the Group of 20/Organization for Economic Cooperation and Development
(G20/OECD)'s Principles of Corporate Governance were progressively strengthened. At the
same time, the creation of the Financial Stability Board (FSB) in April 2009 marked an
important step in the intensification of international coordination on financial governance and
stability matters.3 Established since 1983, the Caribbean Group of Banking Supervisors has also
found its work intensifying in the arena of governance, especially in light of the growing
incidence of cross-border financial mergers, acquisitions and investments.
4. As major central banks were catapulted into the role of picking up the pieces in the
wake of the financial crisis, more scrutiny is being paid to governance in central banks
themselves worldwide. The always influential, but often laid-back, posture of major central
banks (and regulators) was dramatically transformed as the financial crisis unfolded: first,
because regulated banks and other financial institutions were at centre stage of the crisis; and
second, because in attempting to restore order, some of the leading central banks engaged in
novel and unusual transactions on a scale that was virtually unprecedented. Naturally, the
exercise of such power has led to more careful examination of how central banks conduct
themselves. A practical expression of this can be found in the work of the Central Bank
Governance Forum, which was launched under the aegis of the Bank for International
Settlements to foster the good governance of central banks as public policy institutions.4 A 2009
report commissioned by this Forum entitled Issues in the Governance of Central Banks
highlights the complexity and diversity of central banking functions across jurisdiction while
emphasizing that adherence to broad governance principles is essential for all central banks.
Such principles include: i) clear and well specified objectives to carry out their monetary policy
and financial stability functions; ii) appropriate powers and resources, as embedded in legislation
and operationalized in decision making processes; and iii) close alignment of objectives and
incentives, especially by way of transparency about such objectives, procedures and the
stewardship of resources in order to assure accountability.
5. Meanwhile, episodes of market manipulation and collusion also put the spotlight on
It is a cold fact that dishonesty
the presumed integrity of well-established statistical indicators.
and lack of integrity have not only manifested themselves at the individual company level but
also in instances of collusion among companies or among like-minded traders to manipulate and
mislead markets. The information advantage that the manipulators then gain is often a source of
substantial profit. A few well publicized examples come to mind:-the widespread plot by
multiple prominent banks to rig the London Interbank Offered Rate (Libor); collusion by some
banks to manipulate the price of silver; and reports that an early (2 second!) lead in getting data
on a consumer confidence index led to major profit advantages for a select group of firms.
Investigations into such instances bring out the difficulty of uncovering manipulation especially
in the absence of continuous watchfulness or verification. Just two weeks ago the Financial
Stability Board conceded that despite efforts by authorities and firms to strengthen financial
institutions' governance, a further series of high profile misconduct cases had come to light. As a
result, the FSB concluded that more work was needed to promote ethical conduct and
compliance with both the letter and spirit of applicable laws and regulations, which was critical
to public trust and confidence in financial systems.5
6. Turning to Trinidad and Tobago, our financial sector plays a crucial role in mobilizing
The country has a relatively
deposits from savers and channeling such funds into investments.
sophisticated financial system that reaches all aspects of national life: assets of the financial
system account for 216 per cent of GDP. As a result, the average citizen takes careful note of
matters relating to the health of the banks, credit unions and insurance companies that they
interact with regularly. At 44 per cent of total financial system assets, commercial banks play a
dominant role, while insurance company assets are also sizeable at 15 per cent. The banks,
nonbank financial institutions, insurance companies and pension funds are regulated by the
Central Bank. A Securities and Exchange Commission oversees mutual funds and securities
activities, while the Commissioner of Cooperatives currently supervises the credit unions which
provide a vital intermediation function for a large segment of the population. With an open
external current and capital account, the domestic financial sector is closely integrated with the
rest of the world. As a result, financial problems abroad do spill over into the domestic economy.
Given their collective size, influence and international connectedness, it is critical for local
financial entities to rigorously follow strong governance practices; failure to do so would add
another source of deep vulnerability to their own operations and potentially to the wider financial
system.
7.
Episodes of financial failure in Trinidad and Tobago can be linked in part to
governance issues. Like all other jurisdictions, Trinidad and Tobago has had its share of
financial company failures. Most would have been precipitated by a worsening in economic
conditions which unmasked not only fragilities in business practices but also risky investment
patterns and insufficient controls. Among other instances, in the mid-1980s, 5 nonbank financial
institutions that were heavily involved in funding real estate development financed by offering
'80s
depositors above-market interest rates were suspended by the Central Bank. In the late to
'90s
early the indigenous commercial banks confronted severe economic difficulties which
required Central Bank support, and eventually merged operations in 1993. Most recently, in 2009
the collapse of CL Financial Limited (CLF) and related companies represented a major financial
shock not only to Trinidad and Tobago but also to the rest of the Caribbean; CLF's insurance and
banking subsidiaries were at the heart of the imbroglio. In all of these episodes, confidence was
put to the test due to the fear of contagion while, to varying degrees, public resources were
utilized in the search for solutions. But challenges create opportunities: as in the US born crisis
(with the Dodd-Frank Act and stepped-up surveillance), and in Jamaica (with its significant
upgrading of legislation following its own financial crisis in the late '90s), the financial problems
in Trinidad and Tobago prompted improvements in legislation, oversight and self-regulation of
financial institutions.
8.
Nonetheless, the current two-layer governance framework-at the
legislative/supervisory and individual company levels-needs to evolve further. The main bits
of legislation that spell out governance requirements for financial institutions in Trinidad and
Tobago are the Companies Act, which requires directors to ..."act honestly and in good faith
with a view to the best interests of the company", the Financial Institutions Act, Insurance Act,
Cooperative Societies Act and the Moneylenders Act. Bolstering these are Guidelines issued by
the Central Bank to its licensees (banks, nonbanks and insurance companies) on Corporate
Governance and on determining appropriateness of persons to hold key positions in the
organization ("Fit and Proper Guidelines). The governance framework for credit unions is less
well defined, with more discretion left to individual credit unions on how to establish governance
mechanisms and criteria for appointments to directorships and top management positions. Some
financial associations also set out voluntary codes that they encourage their membership to
follow: for example the Bankers Association of Trinidad and Tobago (BATT) has its Code of
Banking Practice, while the Association of Trinidad and Tobago Insurance Companies (ATTIC)
outlined a Code of Ethics. A few years ago several financial and nonfinancial companies in
Trinidad and Tobago came together and set out a comprehensive Corporate Governance Code
(2013). Among other things, this Code put forward best practices on board composition,
monitoring and performance, audits and risk management, and transparency and accountability
in promoting increased disclosure. All of these efforts to improve financial sector governance in
Trinidad and Tobago are laudable and move in the right direction. They do however, need to be
supported by addressing remaining legislative gaps-for example in updating the Insurance
Act-and by concrete actions on implementation!
9.
At the Central Bank of Trinidad and Tobago steps are in train to reinforce governance
Consonant with efforts in these areas by all central
internally and in the oversight of licensees.
banks, in Trinidad and Tobago the Central Bank is moving towards increasing transparency and
strengthening procurement and other procedures. In October 2016 for the first time the Bank
published on its website its 5 Year Strategic Plan,6 in which projects for advances in governance
play a key role, and in April 2017 the Bank launched its internal Whistleblower program. With
respect to governance in licensees, the Bank is collaborating intensely with legislators and
industry participants towards passage of a new Insurance Act that would not only improve
supervisory powers, but would put more onus on boards and managers of insurance companies in
the areas of risk assessment, oversight and compliance. The Central Bank's interactions with
licensees is also adapting in the direction of greater focus on good governance as Inspection
teams engage more actively and regularly with their Boards, internal and external auditors and
risk managers.
10.
Ultimately, financial entities must police themselves and assure that their corporate
culture is founded on resolute commitments to the highest standards of integrity, transparency
and proper controls. It merits reiterating that while legislation, supervision and codes of ethics
and good practice help, in the final analysis it is up to individual institutions to embrace a strong
governance culture. In this regard, boards, depositors and shareholders must embrace the
responsibility of forging the right environment, keeping abreast of developments, and being
ready to act to preserve that environment. Here, let me take the liberty of borrowing from the
work of the Basel Committee on Banking Supervision to offer 7 main principles for financial
institutions:7
i) The board has overall responsibility for the institution, including approving and
overseeing management's implementation of the strategic objectives, governance
framework and corporate culture.
ii) Board members should be and remain qualified, individually and collectively, for
their positions.
iii) Senior management should carry out and manage the institution's activities in a
manner consistent with the business strategy, risk appetite, remuneration and other
policies approved by the board.
iv) Institutions should have an independent risk management structure-risks should be
identified, monitored and controlled on an ongoing basis.
v) The internal audit function should provide independent assurance to the board in
promoting an effective governance process.
vi) The institution's remuneration structure should support sound corporate governance
and risk management.
vii) The governance of the institution should be adequately transparent to its shareholders,
depositors, other relevant stakeholders and market participants.
While these principles were developed for banks, they are of general applicability to all financial
institutions and can be tailored to cater for differences in size and complexity of operations.
Taking one specific example, credit unions in Trinidad and Tobago should utilize these guiding
principles in their own operations and can seek to formalize them as the credit union legislation
is being upgraded.
11.
In conclusion, concerted vigilance is essential to ensure that governance is well
established and indeed remains well entrenched among financial institutions. It is clear that
throughout the world, the movement of money through financial institutions is a high value and
often high risk activity, complicated further by unethical practices often driven by perceived
opportunities for quick riches. As we have seen, the cost of failure can be very high and may not
be confined to a single entity or country. It is impossible to prevent all financial company
failures, and a dynamic economic environment should actually cater for a certain number of exits
and entries over time as depositors' and investors' needs change. At the same time, explicit and
unwavering focus on strong corporate governance can go a long way towards minimizing
problems, including those emanating from large global or regionally integrated financial
institutions. Lessons from turbulent times, here and elsewhere, have resulted in a growing body
of literature, experiences and avenues for collaboration that can be usefully brought to bear on
how to progressively strengthen governance among financial institutions in Trinidad and
Tobago.