Recently, the Union of Arab Banks released a new report on the state of corporate governance in the banking sector in the Middle East and North Africa region. 

The survey of 67 banks from Qatar, Oman, United Arab Emirates (UAE), Yemen, Jordan, and Egypt reveals some interesting trends, mainly that corporate governance mechanisms in the banking sector throughout the region are fairly sound.  Yet, there are areas for improvement.

One might wonder, why does good governance matter at all when we talk about banks?

Financial crises and private sector competitiveness are two terms we ought to think about.  Weak governance mechanisms in banks coupled with weak country-level institutional structures undermine the competitiveness of the private sector.  These conditions increase the chances that loans will be allocated based on personal preferences and insider relationships rather than some set of risk-performance factors.  In an environment where banks can continually mismanage money without any oversight or incentives to focus on long-term value creation, good corporate governance is an effective means of injecting transparency and preventing a financial collapse.

Bank failure as a result of crony, backdoor dealings can ripple through countries, wiping out the savings of the poor and destroying overall trust in the system.  This is especially important in emerging markets where nascent financial institutions struggle to gain legitimacy and trust.

Protection of shareholders’ rights is one of the key areas of concern in developing effective corporate governance mechanisms.

In the surveyed countries, bank shareholders can easily register their ownership, have the necessary mechanisms to transfer shares, can obtain relevant information in a timely manner, and have opportunity to participate and vote in general shareholders’ meetings.  Also, according to the report, 81% of the surveyed banks allow shareholders to obtain compensation for violation of their rights, with the lowest response rate for the question coming from Egypt.

The concept of related party transactions is important in uncovering instances of corruption that appear in forms other than direct bribes.  It becomes more difficult to engage in improper and unethical behavior when related party transactions are reported and scrutinized.  According to the report, 74% of surveyed banks in the Middle East and North Africa region stated that they keep a record of related party transactions that require shareholder approval. 

Further, in terms of unfair share trading, the majority of surveyed banks (88%) stated that their countries have laws or regulations that prohibit insider trading or abusive self-dealing. The same percentage of respondents stated that banks disclose information on allowable transactions by insiders or related parties.

In the area of auditing, 91% of the surveyed banks stated that they have an annual external audit that is conducted by an independent auditor. 

One area where improvement is definitely needed is credit risk assessment.  Only 42% of the surveyed banks indicated that their systems of credit risk assessment include an evaluation of the clients’ corporate governance practices. Also, 62% point out that adherence to sound corporate governance practices has a positive impact on the credit decision-making process. 

The use of corporate governance in credit risk assessment is an effective response to Basel II guidelines.  As John Bohn, former president and CEO of Moody’s Investor Service, noted in a CIPE article several years ago, corporate governance mitigates the risk of using only traditional analysis of profit ratios when looking at loans.  He notes that in corporate governance reform banks can lead by example, by both implementing good corporate governance within themselves and facilitating the development and adoption of corporate governance in other companies.  The fact that only 50% of the surveyed banks in the region are well-informed about corporate governance practices of their corporate clients should be a call for action.

The Union of Arab Banks has now joined forces with Hawkamah Institute in Dubai and the OECD Taskforce on Investment in the Middle East and North Africa to improve standards and enforcement of corporate governance.  Their efforts are a great contribution to the OECD’s push to persuade banks in the region to promote corporate governance in companies through credit mechanisms.