Bank of Uganda
Remarks by
Prof. Emmanuel Tumusiime-Mutebile,
Governor, Bank of Uganda
At the
Breakfast Organised by the Institute of Corporate
Governance Uganda
"Governance as a Core Pillar for Economic
Theme:
Development"
at
Sheraton Hotel.
November 25, 2016
Institute of Corporate Governance of Uganda: Corporate Governance
with the theme
Breakfast "Governance as a core pillar for economic
development"
President, Institute of Corporate Governance Uganda (ICGU)
The Executive of the ICGU Governing Council
Our Host, PWC
Ladies and Gentlemen,
Good morning
I would like to begin by thanking the Institute of Corporate Governance of
Uganda for inviting the Governor to give a key note speech at this breakfast and
to commend the institute for the excellent work that it is doing to promote good
corporate governance in Uganda.
The theme of this breakfast is corporate governance as a core pillar for
economic development. The link between corporate governance and economic
development is probably not intuitively obvious so I will offer you my own
perspective on how corporate governance can contribute to development.
A key driving force of sustainable development is the harnessing of positive
externalities to private sector activities and the minimising of negative
externalities. Positive externalities occur when social rates of return to
investment exceed the purely private rates of return. Examples of positive
externalities include the spillovers of benefits which occur when firms train
workers, invest in research and development and adopt new technologies which
generate "learning by doing' benefits. Examples of negative externalities
include pollution or collusive or abusive manipulation of markets. Given that
investable resources are scarce, long term development requires that social rates
of return are high. Hence rapid economic development is more likely to be
realised in a society which can enable the private sector to generate high private
rates of return to investment while at the same time yielding positive
externalities so that social rates of return are even higher. Conversely, economic
development will be held back if private sector activities create negative
externalities, thus depressing social rates of return to investment.
Why should corporate governance have any impact on positive or negative
externalities of private investment? In any firm there is an inherent tension and
what are often termed the "insiders" of
potential conflict of interest between
- - and the "outsiders" who
firms dominant shareholders and senior managers
include small shareholders, the creditors of the firm, its employees and
customers and the general public. The insiders are those who have actual
control over the form, but without effective restraints insiders may abuse their
control over the firm to derive benefits for themselves at the expense of
outsiders. Examples of this include:

controlling shareholders might extract value from a firm at the
expense of non controlling shareholders;

managers may award themselves huge salaries or bonuses
unjustified by their actual contribution to the success of the
business, and;

managers of a firm might evade paying its proper tax liabilities.
These actions are damaging not just because they transfer resources from
outsiders to insiders of a firm, but also they create incentives for actions which
are socially sub-optimal. For example, if minority shareholders fear that they
will be cheated by controlling shareholders, they will not invest their money in a
company and in a society in which the interests of minority shareholders are not
protected, it will not be possible for firms to raise equity capital except through
internally generated funds.
The essence of corporate governance is to ensure that the actions of a firms
- -
insiders its managers and controlling shareholders are consistent with the
legitimate interests of all of its stakeholders, and do not benefit the insiders at
the expense of outsiders. Corporate governance is not the only defence against
abuse by insiders; there are also legal restraints, for example there are laws to
prevent fraud and ensure minimum standards of health and safety in the
workplace. But it is not realistic to expect the legal system alone to prevent all
possible abuses by insiders; this would be very costly and cumbersome. Hence
there is a need for standards of corporate governance which extend beyond the
strictly legal obligations of a firm.
The banking industry presents unique challenges for corporate governance
because the scope for conflicts of interest between insiders and outsiders is
larger than in many other industries. The scope for conflicts of interest arises for
several reasons. The balance sheets of financial institutions are opaque which
makes it hard for outsiders such as depositors to evaluate their true financial
condition. There are informational asymmetries with insiders having more
accurate information than outsiders. Outsiders typically consist of atomised
individuals which mean that they face "collective action" problems which
impede their acting together in an optimal manner to defend their interests. As a
consequence, the insiders of financial institutions have opportunities to exploit
outsiders in a manner which creates negative externalities such as bank failures
or even financial crises. For example, a bank may be managed in a reckless
manner with any gains made as a result of taking excessive risks accruing to the
owners and managers of the bank while any losses are borne by its depositors or
taxpayers if they have to bail out the bank.
To mitigate the conflicts of interest in financial institutions and avoid negative
externalities, governments impose prudential regulations, such as minimum
capital adequacy requirements for banks, and mandate a public agency to
supervise financial institutions and enforce the regulations. But we also
recognise that statutory bank regulation and supervision by a public agency
such as the Bank of Uganda 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.
The Financial Institutions Act, 2004, includes a framework for good corporate
governance in financial institutions, which is supplemented by a set of corporate
governance regulations which were issued by the BOU in 2005. Uganda's
corporate governance regulations for financial institutions 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 for deposit taking financial institutions 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.
These are also themes which receive emphasis in the King IV report, which I
believe should be viewed as a complement to the corporate governance
requirements which are already in place for the Ugandan financial sector. The
King IV report also includes features which, although not specifically covered
in our own corporate governance regulations because they fall outside the ambit
of prudential concerns, are nevertheless relevant for financial institutions as
well as non financial corporations; these include the importance of corporations
establishing responsible and transparent tax policies and organisation wide
remuneration policies. The King IV Report should help to strengthen standards
of corporate governance both in the financial sector and in the non financial
corporate sectors of our economy.
Thank you for listening.
Prof. Emmanuel Tumusiime Mutebile
GOVERNOR