Corporate Governance: Graduate Seminar

Report on

Basel Committee Principles of Corporate Governance in Banking

Companies

Submitted by:

Mukesh Moktan Tamang

MBA. Trimester VI, Section B

Ace Institute of Management

Submitted to:

Mr. Resham Raj Regmi

Faculty, Corporate Governance

Ace Institute of Management

Kathmandu, Nepal

October, 2022
Introduction to Basel Committee

The Basel Committee is a committee of banking supervisory authorities that was established by
the central bank governors of the Group of Ten countries in 1974. It provides a forum for regular
cooperation on banking supervisory matters. Its objective is to raise awareness of critical
supervisory issues and the quality of banking supervision globally. The Committee develops
recommendations and standards in a variety of sectors, including the internationally recognized
capital adequacy criteria, the Core Principles for Effective Banking Supervision, and the
Concordat on cross-border banking supervision. Basel Committee was established to enhance
financial stability by improving the quality of banking supervision worldwide, and to serve as a
forum for regular cooperation between its member countries on banking supervisory matters. The
Basel Committee, like the other committees, has its own governance structures, reporting lines,
and agendas, which are governed by the central bank governors of the G10 countries.

Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the
prudential regulation of banks and provides a forum for cooperation on banking supervisory
matters. Its mandate is to strengthen the regulation, supervision and practices of banks worldwide
with the purpose of enhancing financial stability.

History of the Basel Committee

The Basel Committee, initially named as the Committee on Banking Regulations and Supervisory
Practices, was established at the end of 1974 by the central bank Governors of the Group of Ten
countries in the aftermath of serious disruptions in international currency and banking markets
(notably the failure of Bankhaus Herstatt in West Germany).

The Committee, headquartered at the Bank for International Settlements in Basel, was founded to
improve financial stability by increasing the quality of banking supervision globally, and to act as
a platform for frequent collaboration on banking supervisory problems among its member nations.
The first meeting of the Committee was conducted in February 1975, and meetings have been held
three or four times a year since then.

The Basel Committee's membership has grown from the G10 to 45 institutions from 28 nations
since its founding. Beginning with the Basel Concordat, which was first issued in 1975 and has

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been revised several times since, the Committee has established a series of international standards
for bank regulation, most notably its landmark publications of the capital adequacy accords known
as Basel I, Basel II, and, most recently, Basel III.

Basel I: The Basel Capital Accord

A capital measurement system commonly referred to as the Basel Capital Accord was approved
by the G10 Governors and released to banks in July 1988. The 1988 Accord mandated that a
minimum capital-to-risk-weighted-assets ratio of 8% be established by the end of 1992. Finally,
this framework was implemented not only in member nations, but in nearly every country with
active international banks. The Committee published a statement in September 1993 verifying that
G10 banks with significant international banking activities were satisfying the Accord's minimal
standards.

The Accord was always meant to change over time. In November 1991, it was revised to more
fully specify the general provisions or general loan loss reserves that might be included in the
capital adequacy calculation. The Committee made another modification in April 1995, which
went into effect at the end of that year, to reflect the implications of bilateral netting of banks'
credit exposures in derivative products and to increase the matrix of add-on elements. Another
paper, issued in April 1996, explained how Committee members expected to recognize the
consequences of multilateral netting.

The Committee also refined the framework to address risks other than credit risk, which was the
focus of the 1988 Accord. The Committee issued an Amendment to the Capital Accord in January
1996 to integrate market risks, which went into force at the end of 1997. This was intended to
include a capital requirement for market risks deriving from banks' exposures to foreign exchange,
traded debt instruments, stocks, commodities, and options in the Accord.

Basel II: The New Capital Framework

In June 1999, the Committee issued a proposal for a new capital adequacy framework to replace
the 1988 Accord. This led to the release of a revised capital framework in June 2004. Generally
known as "Basel II", the revised framework comprised three pillars:

1. minimum capital requirements, which sought to develop and expand the standardized rules
set out in the 1988 Accord

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 2. supervisory review of an institution's capital adequacy and internal assessment process
3. effective use of disclosure as a lever to strengthen market discipline and encourage sound
banking practices

The new framework was designed to improve the way regulatory capital requirements reflect
underlying risks and to better address the financial innovation that had occurred in recent years.
The changes aimed at rewarding and encouraging continued improvements in risk measurement
and control.

Basel III: Responding to the 2007-09 Financial Crisis

Even before Lehman Brothers collapsed in September 2008, the need for a fundamental
strengthening of the Basel II framework had become apparent. The banking sector went into the
financial crisis with excessive debt and insufficient liquidity buffers. In response to these risk
considerations, the Basel Committee produced Principles for effective liquidity risk management
and supervision the same month that Lehman Brothers went bankrupt. The Committee produced
a new set of papers in July 2009 to improve the Basel II capital structure. These changes were part
of a larger attempt to tighten the regulation and supervision of globally active banks in the
aftermath of the financial market crisis.

Principle of Basel Committee of Corporate Governance in Banking Companies

1. Board’s Overall Responsibilities

The board is in charge of the bank overall, including authorizing and supervising
management's implementation of the bank's strategic objectives, governance structure, and
corporate culture.
The board of directors should create and approve the bank's organizational structure.
Members of the board of directors must fulfill their "duty of care" and "duty of loyalty" to
the bank. The board is responsible for managing a good risk governance system, which
includes reviewing key policies and procedures, and should be engaged in defining risk
appetite and ensuring alignment throughout the bank. It should ensure that the risk
management, compliance, and internal audit functions are effective. The board should
appoint the CEO and oversee senior management.

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2. Board Qualifications and Composition
Board members should be and continue to be qualified for their responsibilities, both
individually and collectively. They must grasp their role in supervision and corporate
governance and be able to make good, impartial decisions regarding the bank's business.
The board should be composed of persons with a mix of skills, diversity, and expertise to
permit effective supervision. A sufficient number of independent directors should serve on
the board.
3. Board’s Own Structure and Practices
The board should define suitable governance structures and procedures for its own work,
as well as put in place the means for such practices to be implemented and evaluated on a
regular basis for continued effectiveness. The board should be structured in terms of
leadership, size, and committee utilization. It should keep its rules up to date and conduct
frequent reviews of itself, its committees, and individual board members. The board should
maintain accurate records. The chairman of the board should be an independent or non-
executive member.
4. Senior Management
Senior management shall carry out and manage the bank's activities in accordance with the
business strategy, risk appetite, remuneration, and other policies established by the board,
under the guidance and control of the board. Senior management is a core group of persons
who are responsible and accountable to the board for the bank's sound and sensible day-to-
day management.
5. Governance of Group Structures
The board of the parent company has overall responsibility for the group and for ensuring
the design and operation of a clear governance framework relevant to the group's structure,
operations, and risks. The board of directors and senior management should be familiar
with and comprehend the organizational structure of the bank group, as well as the risks it
entails. Guidance is offered to parent business boards, subsidiary boards, and structures
that are complicated or opaque.
6. Risk Management Function
Banks should have an effective independent risk management function with appropriate
standing, independence, resources, and board access. This job is an important part of the

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 bank's second line of defense and is in charge of supervising risk-taking operations. Large,
complicated, and globally engaged banks, as well as other institutions, should have a senior
manager with overall responsibility for the bank's risk management function, depending
on their risk profile and local governance requirements. The board or its risk committee
must authorize the appointment, removal, and any modifications to the CRO position. If
the CRO is dismissed from his or her post, it should be made public. The reasons for such
removal should be examined with the supervisor of the bank.
7. Risk Identification, Monitoring and Controlling
Risks should be recognized, monitored, and mitigated on a continuous basis across the
bank and by particular entities. The sophistication of the bank's risk management and
internal control architecture should evolve in tandem with changes in the risk profile,
external risk environment, and industry practice.
Significant guidance is offered on the procedures of risk identification, measurement, and
management. The risk governance structure of the bank should comprise rules, backed up
by suitable control procedures and processes, to ensure that the bank's risk identification,
aggregation, mitigation, and monitoring capabilities are proportionate to the bank's size,
complexity, and risk profile. Both quantitative and qualitative factors should be included
in risk identification and measurement.
8. Risk Communication
An effective risk governance system necessitates frequent risk communication with the
bank, both internally and through reporting to the board and senior management. There
includes advice on risk communication, information, reporting, and risk systems. A crucial
aspect of a successful risk culture is continuous communication about risk problems,
including the bank's risk strategy, throughout the organization. Risk reporting systems
should be dynamic, comprehensive, and accurate, with a variety of underlying
assumptions.
9. Compliance
The board of directors of the bank is in charge of supervising the management of the bank's
compliance risk. The board of directors should create a compliance function and adopt the
bank's policies and procedures for detecting, analyzing, monitoring, reporting, and advising
on compliance risk. An independent compliance department serves as the bank's second

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 line of defense, ensuring that the bank operates with integrity and in accordance with
relevant laws, regulations, and internal rules.
10. Internal Audit
Internal audit should give independent assurance to the board and assist the board and
senior management in supporting an effective governance process and the bank's long-term
viability.
The third line of defense in the internal control system is an effective and efficient internal
audit function. The internal audit function should have a defined mission, report to the
board, and be completely independent of the audited operations. If the top audit executive
is dismissed from his or her post, the reasons should be made public, and the reasons should
be reviewed with the bank's supervisor.
11. Compensation
The remuneration structure of the bank should promote good corporate governance and
risk management. The board, or by delegation, the compensation committee, is in charge
of overall monitoring of management's execution of the pay system for the whole bank,
including the examination of results relevant to the incentives created by the remuneration
system.
12. Disclosure and Transparency
The bank's governance should be transparent to its shareholders, depositors, other
important stakeholders, and market players. All banks must publish yearly the recruiting
strategy for board member selection and board composition, as well as if the bank has board
committees and how frequently major standing committees meet. In general, banks should
follow the OECD guidelines on disclosure and openness. Key points relating its risk
exposures and risk management procedures should be provided without jeopardizing
appropriate confidentiality. Adequate information on the goal, strategies, structures, and
relevant risks and controls should be revealed for major and complicated or opaque
operations. Disclosure must be accurate, concise, and timely.
13. The Role of Supervisors
Supervisors should provide guidance for and supervise corporate governance at banks,
including through comprehensive evaluations and regular interaction with boards and

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 senior management, and should require improvement and corrective action as needed. They
should also share corporate governance information with other supervisors.
Supervisors should lay forth expectations for good corporate governance. They should
perform thorough assessments of a bank's corporate governance. Supervisors should
communicate with directors and upper management. A bank should be required to improve
and correct them. Supervisors should work together and exchange information on company
governance with other appropriate supervisors.

How is Basel Committee principles globally practiced?

Basel Committee seeks to achieve its mandate globally through the following activities:

1. Exchanging information on developments in the banking sector and financial markets, to

help identify current or emerging risks for the global financial system;
2. Sharing supervisory issues, approaches and techniques to promote common understanding
and to improve cross-border cooperation;
3. Establishing and promoting global standards for the regulation and supervision of banks as
well as guidelines and sound practices;
4. Addressing regulatory and supervisory gaps that pose risks to financial stability;
5. Monitoring the implementation of Basel Committee on Banking Supervision (BCBS)
standards in member countries and beyond with the purpose of ensuring their timely,
consistent and effective implementation and contributing to a "level playing field" among
internationally active banks;
6. Consulting with central banks and bank supervisory authorities which are not members of
the BCBS to benefit from their input into the BCBS policy formulation process and to
promote the implementation of BCBS standards, guidelines and sound practices beyond
BCBS member countries; and
7. Coordinating and cooperating with other financial sector standard setters and international
bodies, particularly those involved in promoting financial stability.

How is Basel Principles practiced in Nepal?

Nepal Rastra Bank (NRB) Strategic plan 2012-16 has spelled out about the beginning of
implementation of Basel III by 2015. Basel III has increased the capital and liquidity requirements

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for the banks. Such increase in capital and liquidity is likely to bring some impacts in the financial
sector as well as economy as a whole.

The Macroeconomic Assessment Group (MAG) of the Financial Stability Board (FSB) and Basel
Committee on Bank Supervision (BCBS) has concluded that one percentage point increase in the
ratio of capital to risk-weighted assets results in a median increase in bank lending spreads of
approximately 15 basis points. On December 17, 2010, the Basel Committee released a report on
the likely macroeconomic impact of Basel III. It indicated that full compliance with Basel III is
likely to result in a small dip in real GDP growth. The OECD estimates that the implementation
of Basel III will decrease annual GDP growth by 0.05-0.15 percent.

The possible impact of Basel III in capital, liquidity and profitability of the banks of Nepal are:

• Nepalese banks have very low (almost negligible) level of exposures in trading book,
securitized instruments and derivatives. Therefore, there is very minimum probability of
increase in risk assets as a result of implementation of Basel III.
• Initiating new liquidity requirement as per Basel III will not be a very new and complex
issue in the context of Nepal. However, some exercise is necessary to initiate the Net Stable
Funding Ratio (NSFR).
• In case of Nepal, the impact of Basel III in earning is likely to be less than that of Europe
(4 percent) and USA (3 percent) since there will not be a significant level of additional
capital requirements for the securitized assets, derivatives and trading portfolios.

Conclusion
Nepalese banking system has not yet achieved the level of development and advancement of
international standard. There are number of shortcomings and limitations in the system like;
absence of credit rating practices, absence of internal rating of credit by banks, weak corporate
governance, absence of strong macro-prudential measures and regulatory compliance. There will
be a need of increased level of capital and liquidity after implementation of the Basel III.
Implementing new capital and liquidity requirements as prescribed under Basel III will not be very
complex issue in the context of Nepal. Moreover, there is sufficient period of transition
arrangement as given. But there is a need of a timely development and issuance of regulation for
the effective implementation of Basel III capital regulations in Nepal.

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 References

Basel Committee on Banking Supervision. (2010a). Basel III: A global Regulatory Framework for
More Resilient Banks and Banking Systems. Bank for International Settlements

Basel Committee on Banking Supervision. (2012). A framework for dealing with domestic
systemically important banks. Bank for International Settlements.

Basel Committee. (2010b). Basel III: International Framework for Liquidity Risk Measurement,
Standards and Monitoring. Bank for International Settlements

Goodhart, C (2011): The Basel Committee on Banking Supervision: A history of the early years
1974-1997, Cambridge University Press.

Slovik, P. and B. Cournède (2011), “Macroeconomic Impact of Basel III”, OECD Economics
Department Working Papers, No. 844, OECD Publishing