Good corporate governance promotes transparency, which in its own turn encourages investment
Category: Corporate Governance
The fourth chapter of the OECD Principles of Corporate Governance endorsed by the OECD council in 1999 is solely devoted to Transparency and Disclosure.
Market transparency is a simple concept that brings huge private and public rewards. Adoption of good disclosure practices makes the financial markets fair and thus encourages people to invest their savings. What is also important is the transparency of not just markets but transparency of companies. Transparency, which applies to self-dealing and share trading by management as well as company revenues and profits also gives substance to shareholder rights by providing the information essential to their decisions.
Also, good disclosure forces Supervisory Councils and Management Boards of banks to manage better and thus benefits employees, investors and the country as a whole. When speaking about corporate governance the first thoughts that come to mind are the legal requirements and structures of the Supervisory Councils and Management boards. However, the very positive effect on corporate governance itself is the financial reporting system, and in particular, full transparency and disclosures.
The absence of a large, long term shareholder (e.g. «the main bank» system that dominate in the German industry) can be compensated by vast mass of shareholders and investors (e.g. US and UK capital markets) thanks to the system of full transparency and good disclosure.
Transparency seems simple but is highly complex
Transparency is easy to define but in the reality is complex and difficult to maintain. It has many dependent parts. The financial markets depend on good disclosures. The entire history of financial markets demonstrates the need for government laws, rules, oversight and discipline to ensure that investors receive the information they need.
Also, financial reporting rests on the variety of difficult judgments, such as provisions, contingent liabilities, revenue recognition and other factors. The goal to make financial reporting consistent from year to year and comparable across banks is not an easy task. Even with government regulation, market abuse and excesses are possible, and without it, they are inevitable.
Apart from demands of the financial markets, transparency is effected by other groups of participants, such as:
accounting standard setting groups, that operate under the oversight of the security exchange commissions (e.g. in the US, the Financial Accounting Standards Board is privately run but operate under the oversight of SEC) or other government bodies (e.g. in Ukraine, the accounting standards are set by the Ministry of Finance);
security analysts who prepare economic and industry analyses for investors on the basis of company-specific reports;
credit rating agencies which do similar work (as security analysts) for banks and other lenders and often have preferred access to data;
investment banks which market new issues of shares to investors;
major law firms which structure complex transactions that can be used to enhance or defeat transparency; and
audit firms: if disclosure begins with management it surely ends with accountants.
Comprehensive, accurate, relevant and timely public disclosure benefits:
bank — it enables the bank to access capital markets more efficiently and strengthens their market discipline;
shareholders -it enhances the wider set of shareholders to participate in the governance of the bank and makes the corporate governance process more transparent;
market participants — because they can use the information as a basis for making various types of business decisions;
bank supervision — it enables them to control systemic risks and take early corrective measures.
There are inherent difficulties in making a bank transparent:
financial strength and performance may be heavily dependent on accounting estimates (such as loan impairment and various provisions) and therefore, is a subject to certain degree of uncertainty;
important elements of banks’ risk strategy and internal controls may be difficult to communicate meaningfully and as a result, difficult to make transparent sometimes;
banks, due to the need to preserve a degree of confidentiality, can not publicly disclose all data that may be relevant to assessment of its activities and risk exposures.
Privacy laws may restrict a bank’s ability to disclose information on individual customers; sometimes costs involved in preparing public disclosures (e.g. publication costs; costs in developing, implementing and maintaining the system to generate the required disclosures etc) can be very significant. banks are not motivated to promote full transparency when:
disclosure standards are not reinforced by government and regulators and shareholders, creditors and market participants tend to rely on secondary information (credit ratings, media and rumors);
bank heavily rely on retail deposit customers that may lack skills to monitor a bank’s condition via its public disclosures;
a bank is on the brink of bankruptcy, its share capital eroded — shareholders may have an economic interest to tolerate or promote risky strategies, since they have little to lose.
In many countries, comprehensive accounting and reporting guidance is available on the presentation and disclosure of main categories of information, each of which should be addressed in clear terms and appropriate detail to help achieve a satisfactory level of bank transparency.
Great volume of authoritative guidance has been issued by legislators, regulators, national and international accounting standard-setters. This can be used as a reference source to identify appropriate disclosures and to gain an understanding of why they are useful.
Example
In 2001, Trema Group (the premier provider of strategic software solutions for the financial industry) issued the annual survey on financial risk management disclosure. The survey covered the 2000 annual reports of 45 large European banks from 14 countries. The main focus of the survey was the level and quality of disclosures in the following areas:
strategic risk and shareholder value information;
credit risk;
market risk;
operational risk;
assets and liability management;
These areas included about 70 items, including description of definitions, risk management methods and tools, description of policies, strategies and objectives, quality and extent of quantitative data, organization and reporting issues. Each items was graded on a scale of0to5: 5 -excellent/best practice, 3 — satisfactory, 1 — inadequate, 0 — no information.
There were considerable differences in the level of risk disclosure among surveyed banks. These differences were largely due to cultural differences between geographic areas and especially due to differences in the size of the banks. In general, Nordic, German and Swiss banks tend to present the best disclosures on risks, although British and Spanish banks are also among the top performers. Usually, larger banks tend to disclose more information than smaller ones. However, the difference in the level of disclosure between the worst and best performers were alarming.
The Basel Committee considers bank transparency to be of the utmost importance. Financial market players can reinforce the efforts of bank supervision if they have access to timely and reliable information which enables them to assess a bank’s activities and the risks inherent in those activities. Toward this end, banks and bank supervisors need to ensure that appropriate disclosures are being made.