What Is the Role of Corporate Governance in Financial Institutions?

Corporate governance in financial institutions is the set of standards and principals used to create a system of checks and balances over the management of banks and financial intermediaries. It establishes the way financial institutions are directed and controlled, ordinarily through standards set for the conduct of the board of directors and senior management. Countries have different political and regulatory environments, business standards and customs. Additionally, independent legal systems varying from country to country cause significant differences in corporate governance practices. There is, however, an international movement toward universal standards for all multinational financial institutions that has been gaining traction since the late 1990s.

The topic of corporate governance of financial institutions and its role in stabilizing the industry has reached new levels of importance since the mid 1990s as a result of the globalization of financial markets, deregulation and technological change. These positive factors, together with the poor management, corruption and fraud that resulted in multiple financial crises in major industrialized countries over a number of years brought the role of corporate governance in financial institutions to the forefront in many countries and in the international economic community. Governments around the world recognized that management opacity and poor disclosure requirements for banks and financial intermediaries was a significant factor in destabilizing financial markets and disrupting economies worldwide.

Consequently, the concept of corporate governance of financial institutions took on a more defined role in the regulatory environment of many countries and drove the adoption of specific international standards promoted by the Organisation for Economic Cooperation and Development (OECD) and the Basel Committee on Banking Supervision (BCBS). Corporate governance is now viewed as a prominent way to manage risk, prevent crises and preserve shareholder value. It requires the two-pronged structure that provides direction and management at the top of financial institutions in any country to commit to transparency and accountability in business operations.

International standards define the role of corporate governance in financial institutions as a mechanism for establishing corporate values and implementing clear lines of responsibility. Proper governance ensures that the members of the board of directors are qualified to provide meaningful oversight and are competent in their duties. It also provides for internal and external audit procedures and ensures a consistent and rational compensation structure for senior management. Most importantly, the role of corporate governance in financial institutions under the international paradigm is to ensure a level of transparency that can alert regulators and the public of problems before they become crises.