Governance of the financial sector has emerged as an important factor in financial stability. Particularly in the transition economies where the legal and regulatory infrastructure is still in need of further strengthening, corporate governance has become recognized as
an important factor in establishing trust in the financial system and in ensuring that bank depositors, insurance policyholders, and small shareholders have confidence that their funds have been entrusted to competent and honest administrators. Poor governance erodes customer confidence in banks and financial institutions and deters potential customers from (a) placing deposits with the bank, (b) transferring savings to an investment fund, or (c) purchasing an insurance policy. Poor corporate governance also makes it more difficult for financial institutions to raise additional equity capital, especially from investors outside the group of current shareholders.
A strong corporate governance framework improves the quality of the enterprise sector and is an important issue in determining the quality of a country’s investment climate. Well-governed companies are likely to be more creditworthy as bank borrowers. In addition, the equity shares of well-governed corporations can provide solid investments for investment funds, pension funds, and insurance companies. Where weak corporate governance is associated with insufficient competition in the business sector, improved corporate governance practices can open the way for new entrants and increase competition for customers and new markets.
A corporate governance framework encompasses three primary areas:
Laws, regulations, and decrees that provide the legal framework for the commercial sector
Regulatory agencies responsible for the enforcement of legislation Common marketplace practices (or business culture) that, in some countries, are as important as legislation and institutions
In the financial sector, it is important that the legal framework provide for (a) the ownership structure of banks, (b) appropriate fit and proper provisions for shareholders and key administrators, (c) transparency, and (d) strong regulatory oversight. The law also should provide detailed stipulations for the obligations of directors; directors’ duties of care; procedures for the convening, operation, and termination of meetings; the relationship between management and owners; shareholder rights; audit responsibilities; accounting practices; public access to the records of the company registry; ability of the shareholders to obtain copies of shareholder lists; disclosure of shareholdings by public sector officials; fiduciary obligations of members of boards; and presence of codes of corporate conduct.