The Banking Supervision Department’s Activity Regarding Corporate Governance in the Banking System

Abstract

 

  •     Corporate governance is the foundation of proper conduct of financial institutions in general, and of banking corporations in particular. Its goal is to maintain the stability of the banking system and of depositors’ funds, and to protect the system’s customers and the public in general. Corporate governance deals with, among other things, supervision and control, risk management, compliance with legislation and regulation, and organizational culture. Adequate corporate governance promotes appropriate exposure to risks and a high level of compliance, while paying close attention to appropriate decision making processes and challenging management and decision makers. It is reflected primarily in the proper conduct of the corporation’s functions and the gatekeepers—the board of directors, the external auditor, the internal audit, the Chief Risk Officer, the general counsel, the Chief Compliance Officer, and the Chief Accountant. In recent years, public interest in corporate governance has increased, so this survey of activity is being published, as part of the policy of enhancing transparency of the Banking Supervision Department.
  •       Over the years, the Banking Supervision Department has placed particular emphasis on strengthening the corporate governance regime in Israel’s banking system, through a range of supervisory tools, such as regulation—publishing Proper Conduct of Banking Business Directives that obligate the banking system, ongoing supervision, examinations at banking corporations, and enforcement measures. Leading international entities, such as the IMF, have expressed high regard for the Banking Supervision Department’s activity in general, and in the area of corporate governance in particular, in examinations they have conducted at the Banking Supervision Department. Domestic entities as well, that deal in the sector, consider the banking system’s corporate governance regime the most developed and organized of all the businesses in Israel.
  •        While regulation activity is inherently public, on-site examination activity is not publicized. This work method, which is characteristic of leading regulators worldwide, is backed by law, and is necessary in order to maintain the effectiveness of the supervision, as it ensures the Banking Supervision Department unfettered access to the banks’ core business operations and full cooperation by the supervised entities.
  •       In the area of regulation, the importance of corporate governance in the banking system was consistently taken into account by the Banking Supervision Department over the years of its activity. From many perspectives, the standards set by the Banking Supervision Department were pioneering compared with the regulation and legislation regarding other public companies. Documentation of this appears back in 1973, with the publication of the first Directive regulating the aspects of corporate governance in the work of the banking corporation’s board of directors, beyond what was required by the law in general. The importance of corporate governance became extremely clear following the 1983 Israel bank shares crisis, and since the late 1980s more than 50 regulation activities have been published, setting standards in the sector, including approximately 20 updates and changes in the Directive regarding the Board of Directors. As of today, at least 13 Proper Conduct of Banking Business Directives deal directly with corporate governance, and three of them deal with, among other things, preventing conflicts of interest. The regulation directives, as well as additional activities by the Banking Supervision Department, establish detailed requirements regarding the corporate governance regime, and they add to—to a large extent, they increase the strictness of—the provisions of the law. In the past year, the Banking Supervision Department again revised the Directive dealing with the Board, in order to strengthen the effectiveness of that function.
  •       Examinations are an effective tool for ensuring compliance with the requirements of corporate governance and for strengthening it: Documentation of the Banking Supervision Department’s activities since the end of the 1990s indicates that more than 110 designated examinations have been carried out in the banking system on the issue of corporate governance. Of those, more than 30 examinations dealt with the board of directors and its committees, approximately another 30 concentrated on the issue of internal audit, and at least 15 dealt with examinations of anomalous events that are relevant to corporate governance. In addition, findings in the area of corporate governance often come up in examinations carried out in other areas. For example, preventing conflicts of interest came up in examinations on the issue of credit risks as well.
  •       Enforcement and sanctions: In the banking system, like in any other system, supervision and control—as intensive as they may be—are not enough to totally avoid failure occurrences. The Banking Supervision Department locates and deals strictly with failure events in the area of corporate governance. In the past decade, in at least 16 cases, the Banking Supervision Department’s intervention led to banking corporations terminating the tenure of employees, executives, or senior advisors, or preventing their advancement, or their service in gatekeeper positions, due to findings of weakness in corporate governance or due to concern of the potential for conflicts of interest. Often, intervention by the Banking Supervision Department does not reach the imposing of enforcement authorities or sanctions under the law, because the banking system is characterized by a high level of compliance and rapid responses by the banks to correcting deficiencies based on the Banking Supervision Department’s requirements. When concern arises of a criminal offense being committed, the Banking Supervision Department transfers material to prosecutors or the police, for consultation, examination, or investigation, as relevant.
  •         The Fit and Proper process as a tool for ensuring the quality of corporate governance. The appointment and extension of the term of a considerable portion of bank employees[1] is subject to the approval of the Banking Supervision Department, in accordance with its authority under the law. The Banking Supervision Department’s requirements set a strict threshold for expectations in terms of the qualifications and integrity of the candidates for those positions. If a banking corporation’s preliminary examination regarding a candidate meeting the threshold indicates that there will be a difficulty in the Banking Supervision Department’s approval of the candidate, no request will be submitted at all. Nonetheless, in approximately 3 percent of the requests that were examined by the Banking Supervision Department in the past 3 years, the candidacy was withdrawn during the discussion of the request, by the bank or by the candidate. In addition, in approximately 20 percent of the requests submitted in the past 3 years, the approval was made contingent on various stipulations aimed at, among other things, preventing conflicts of interest.
  •      The importance of corporate governance was also emphasized within the framework of ongoing work: In the Supervisory Review and Evaluation Process (SREP), the Banking Supervision Department assesses, among other things, the appropriateness of the corporate governance regime at each bank, including the quality of the functioning of the board of directors, management, and the various gatekeepers—at the level of the function as well as at the personal level. As a result of this process, the Banking Supervision Department presents requirements for rectifying deficiencies, including the improvement of corporate governance. Thus, for example, weaknesses in corporate governance can lead to the Banking Supervision Department requiring that a bank increase its capital adequacy.



[1] Section 11a(h)(1) of the Banking Ordinance.