What exactly is Governance?
Governance, generally, means the process of decision making and the process by
which decisions are implemented involving multiple actors.
Good governance is accountable, transparent, responsive, equitable and
inclusive, effective and efficient, participatory and which is consensus
oriented and which follows the rule of law.
Good governance is essential for any entity; it has deeper significance for
financial institutions.
There are many compelling reasons, some of which are:
o Financial institutions are central to economic activity – banks and a large
part of the non-banking financial system which are the shadow banking system
undertake credit intermediation. Failures of financial institutions would thus
clog the economic growth and would cause serious damage to the system. Economies
take longer time to reverberation from financial crisis than the business cycle
recessions.
o Financial institutions operate on a higher leverage. As per a study by the
Bank for International Settlement (BIS) for the period 1995–2009, compared to
non-financial institutions that had a leverage of about 3, banks operated at a
leverage of 18.3 while non-bank financial firms had a leverage of 12.1. Higher
leverage makes financial intermediaries more vulnerable to shocks. It is
apparent that these financial institutions must be well governed for achieving
financial stability.
o Financial institutions, especially banks, deal in people’s savings and trust
of customers forms the cornerstone of their existence. Any rupture of trust
leading to loss of confidence is bound to lead to a run, not just on a
particular bank but on others too who are perceived to have weakness or even
similar business models. The non-bank financial intermediaries who lose the
trust of their lenders would not be able to raise resources at a reasonable cost
making it hard for them to operate efficiently and profitably. All these can
lead to snowballing effect impairing the functioning of the entire financial
system due to interconnectedness. Good governance ensures customers’ and other
stakeholders’ trust in banks and non-banking financial intermediaries.
o Among the financial intermediaries, banks occupy a special place due to their
centrality in the transmission of monetary policy and the functioning of the
payment and settlement systems. They also are the beneficiaries of deposit
insurance which may weaken their incentive for strong management monitoring as
well as monitoring by other stakeholders including depositors. Good corporate
governance would ensure strong internal controls which would offset the weakened
incentive for monitoring. A robust and stable banking system.
Effective corporate governance mobilises the capital annexed with the promotion
of efficient use of resources both within the company and the larger economy. It
also assists in attracting lower cost investment capital by improving domestic
as well as international investor’s confidence. Good corporate governance
ensures the accountability of the management and the Board.
Dr Shahid Javaid Burki—a long observer of Pakistan’s economy has recently stated
“Pakistan can generate a greater bounce in its economy than India by creating
better governance. It has occurred before in the country’s difficult economic
history and could happen again.” (Improved Governance: Dawn, 12th, October
2010).
According to A Survey of Corporate Governance Practices in Pakistan, 2007‖,
conducted by International Finance Corporation and SECP, 92 per cent respondents
prepare annual Statement of Ethics and Business Policy‖, 48 per cent had Vision
and Mission Statement‖, and none of the respondents have Code of Corporate
Governance.
On the other hand, it was also found that 50 per cent of the corporations in
Pakistan did not include non-executive directors in their board of directors, 54
per cent have not introduced transaction administration procedure, 53 per cent
have not implement a formal remuneration system, and 55 per cent did not have
corporate governance improvement plan. Whereas, 31 per cent respondents did not
identify the barriers to improve the corporate governance, 69 per cent
identified the barriers, 42 per cent had non availability of qualified staff to
implement and 21 per cent did have the claim that corporate governance produces
sensitive information that cannot be shared with the competitors.
The relationship between corporate governance and the value of a firm differs in
emerging and mature financial markets due to disparate corporate governance
structures in these markets resulting from dissimilar social, economic and
regulatory conditions in these countries. When an investor feels himself more
secure, he will invest more. For making the firm more profitable, one should
protect the rights of the investor. This can only be happen if the firm has
strong corporate governance structure.