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TRANSCRIPT
The governance of banks in transition economies FYR Macedonia country report
2012
FYR Macedonia Country Report – 2012 PAGE 2 of 24
Table of content
Table of content .................................................................................................................... 2
Foreword .............................................................................................................................. 3
A. Methodology and overview of the banking system in FYR Macedonia .............................. 4
1) Methodology ....................................................................................................................... 4
2) Overview of the banking sector in FYR Macedonia ............................................................ 4
B. Key findings ..................................................................................................................... 8
1) The strategic and governance role of the board ................................................................ 8
2) Composition and functioning of the board....................................................................... 10
3) Risk Governance ................................................................................................................ 13
4) Internal Control ................................................................................................................. 15
5) Incentives and Remuneration ........................................................................................... 18
6) Transparency to the market and regulators ..................................................................... 20
7) Overall assessment of bank governance quality in FYR Macedonia................................. 22
This Report does not constitute legal advice. Readers are advised to seek appropriate legal advice before entering into any transaction, making any determination or taking any action related to matters discussed herein. The contents of this Report are copyrighted. The assessments and views expressed in the Report are not necessarily those of the EBRD. All assessments and data in the Report are based on information gathered in the course of 2011.
For information or comments please contact Gian Piero Cigna at [email protected]
FYR Macedonia Country Report – 2012 PAGE 3 of 24
Foreword
1. In July 2010, the Legal Transition Team of the EBRD launched a comparative assessment of the corporate governance of banks in its countries of operations. The overall objective of the assessment is to inform and support the EBRD’s policy dialogue with authorities with a view to generating further commitment to improve the corporate governance of banks in EBRD countries of operations. The assessment aims at providing the EBRD with an overview of the legal and regulatory framework governing the corporate governance of banks and how diligently the various rules and best practice guidelines are implemented.
2. The assessment focuses mostly on internal corporate governance arrangements in banks, particularly the role and composition of boards. It analyses the legal and regulatory framework; its implementation by supervisors; and the practices developed by the systemically important banks in each country. The transparency of governance arrangements to the supervisory authority and the markets is also reviewed. While the assessment analyses banks and their boards, and considers ownership structure and patterns in the banking sector, broader governance issues covered in the OECD Principles such as shareholder and stakeholder rights and responsibilities as well as equity market issues are not dealt with in any detail.
3. To enhance the EBRD’s understanding of the corporate governance of banks in countries of operations, countries reviewed are subjectively rated. For this purpose, the legal framework, supervisory practice and banking practice are given an overall score in the executive summary section of each Country Report. In addition, the performance of countries in the key areas mapped out in the EBRD checklist is also rated. The rating approach is detailed in the box below.
Rating
“Strong to very strong” - The corporate governance framework / practices of supervisory authorities /
practices of banks are fit for purpose and are close to best practice.
“Moderately strong” - Most parts of the corporate governance framework / practices of supervisory authorities / practices of banks are adequate but further reform is needed “Weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain some elements of good practice but overall the system is in need of reform “Very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain significant risks and are in need of significant reform
4. Each Brief Country Report is divided in two Sections: (A) Methodology and overview of the banking system; (B) Key findings – describing the strengths and weaknesses of the corporate governance of banks and policy recommendations where appropriate.
FYR Macedonia Country Report – 2012 PAGE 4 of 24
A. Methodology and overview of the banking system in FYR Macedonia
1) Methodology
5. The analysis and recommendations contained in this report are based on research carried out by the EBRD and responses to written questionnaires sent to one law firm; the National Bank of Republic of Macedonia (hereafter the ‘NBRM’); and two among the largest banks of the country (‘the banks reviewed’). Responses to the questionnaires were complemented by a desk research of FYR Macedonia legislative framework, and on-line information about the country’s banking sector.
Exhibit 1: The three largest banks in FYR MACEDONIA by share of total banking assets and listing at the end of 2011
Bank name (3 largest banks) Total Assets in
million of Denar Share of total asset of banking system (%) *
Listing on SE
1. Komercijalna Banka 80,153 24.20 Macedonian Stock Exchange (MSE)
2. Stopanska banka Skopje 70,548 21.30 MSE
3. NLB Tutunska banka 61,667 18.62 MSE
Total three largest banks 212,368 64.13
Total banking system 331,176 100
Based on the banks’ Audited Financial Reports 2011 and Report on the banking system in the Republic of Macedonia in 2011
2) Overview of the banking sector in FYR Macedonia
6. At the end of 2011 the banking system in FYR Macedonia was comprised of 17 banks.1 The total assets of the financial sector of the Republic of Macedonia increased of 9.2 % in 2011, which is by 3.9 percentage points less compared to the growth in 2010. The deceleration of the growth of total assets of the financial system was mainly attributable to the slower growth of the funds of the banking system and to a lower extent, to the assets of the pension funds. The financial sector in FYR Macedonia is characterized with a simple structure, where the banking system is the most significant segment, and the role of non-depositary financial institutions is still insignificant. In 2011, banks maintained their role as a crucial institutional segment for preserving the stability of the overall financial sector, notwithstanding the minor decrease of their share in the overall financial potential.2
1 Report on Banking System and Banking Supervision in Republic of Macedonia in 2011, see at:
http://www.nbrm.mk/WBStorage/Files/WebBuilder_SupervisionAnnual_31_12_2011_ang.pdf 2 Financial Stability Report for the Republic of Macedonia in 2011, see at:
http://www.nbrm.mk/WBStorage/Files/WebBuilder_SupervisionAnnual_31_12_2011_ang.pdf
FYR Macedonia Country Report – 2012 PAGE 5 of 24
Exhibit 2: Number of Financial Institutions in FYR Macedonia and their ownership structure
Source: BSCEE Review 2011
7. At the end of 2011, thirteen out of the seventeen banks in the country are predominantly owned by foreign shareholders. Compared with December 31, 2010, the number of banks in dominant ownership of foreign shareholders is reduced by one, due to the acquisition of "Stater Banka" AD Kumanovo by "Centralna Kooperativna Banka" AD Skopje (both in dominant foreign ownership). Eight are subsidiaries of foreign banks and banking groups. At the end of 2011, market share (share in the total assets of the banking system) of subsidiaries of foreign banks declined by 1.9 percentage points and accounted for 59.4% 3 The majority of assets of the banking system are concentrated with the banks with dominant ownership by shareholders from the EU (primarily from Greece and Slovenia). However, at the end of 2011, the EU share dropped to 70.8% (from 76.6% in 2010) as a result of the increased participation of capital from Turkey.4 At the end of 2011, foreign capital participated with 92.4% in the overall capital of the banking system of the Republic of Macedonia.
3 Report on Banking System and Banking Supervision in Republic of Macedonia in 2011, p. 15
(http://www.nbrm.mk/WBStorage/Files/WebBuilder_SupervisionAnnual_31_12_2011_ang.pdf) 4 In the last six months of 2011, the share of Turkish foreign capital in the total foreign capital increased by 8.2
percentage points, to 16%.
FYR Macedonia Country Report – 2012 PAGE 6 of 24
Exhibit 3: Foreign participation in the banking sector in FYR Macedonia
Structure of more important positions in banks’ balances according to dominant ownership of banks
Dynamics of share of banks’ subsidiaries assets in total assets
Source: Report on Banking System and Banking Supervision in Republic of Macedonia in 2011
8. According to the EBRD country strategy, FYR Macedonia has built a strong record of macroeconomic stability in recent years. GDP growth reached 5.9% in 2007 and 4.8 % 2008 respectively, led by stronger domestic demand and increasing investments. In the last quarter of 2008 and in the first half of 2009, however, the economy began to feel the impact of the global financial crisis. Exports, capital inflows and investments as well as industrial production dropped significantly, with the metal sector being hit particularly hard. The banking sector has been less affected due to FYR Macedonia’s lower level of financial integration, limited financial intermediation and improvement in regulation and supervision.
9. Credit risk is the dominant risk in the banking activities. As of the end of 2011, the non-performing loans (NPLs) to non-financial entities equaled Denar 20,089 million, and registered an annual rise of Denar 2,800 million or by 16.2% (in 2010 was Denar 1.512 million or 9.6%). That led to a rise in the NPL ratio for non-financial entities from 9.3% at the end of 2010 to 9.9% at the end of 2011. From the sector perspective, the increase in NPLs to non-financial entities was mainly due to the increase of these loans to enterprises, while the non-performing loans to households and other clients decreased.
Exhibit 4: Number of Financial Institutions in FYR Macedonia and their ownership structure
Source: BSCEE Review 2011
FYR Macedonia Country Report – 2012 PAGE 7 of 24
Supervisory framework
10. According to the Law on the National Bank of the Republic of Macedonia and the Banking Law, the National Bank of the Republic of Macedonia (“NBRM”) is the only supervisory authority responsible for licensing and supervision of banks and savings houses in the country
11. There is also the Securities and Exchange Commission of the Republic of Macedonia; however, it plays a limited role in regulating the banking sector.
12. There is a stock exchange in the country, the Macedonian Stock Exchange with market capitalisation at the end of 2011 of USD 2.58 billion. There were 65 companies registered with the MSE at the end of 2011 and the MSE average daily volume of stocks at the end of 2011 was USD 217,500. All three largest banks in FYR Macedonia are registered with the MSE.5
Laws and regulations relevant for corporate governance of banks
Exhibit 5: Laws and regulation on the corporate governance of banks6
Laws
1. Banking Law, dated 2007 as amended in 2009 and 2010; 2. Law on the National Bank of the Republic of Macedonia, dated 2010; 3. Law on Companies, 2004 – includes main provisions about joint stock companies.
Secondary Acts:
1. Decision on Basic Principles of Corporate Governance in a Bank, 2007, NBRM (it sets forth basic principles of corporate governance in a bank). In line with Art. 82(3) of the Banking Law, the decision is mandatory.
2. Decision on Reports and Data Disclosure by the Bank, 2007, NBRM (it prescribes the report and the data each bank is required to disclose, as well as the manner, the form and the deadlines for their disclosure).
3. Decision on the Method of Determining Connected Persons/Entities, 2008, NBRM (it set forth the method of determining connected persons/entities and persons/entities connected to the bank, for the purposes of bank founding and operating);
4. Decision on the Risk Management, 2008 (it prescribes the methodology for managing risks the bank is exposed to during its operations);
5. Decision on Exposure Limits, 2008 6. Decision on Credit Risk Management, 2008 7. NBRM Supervisory Circular Letter No 4 on Corporate Management in Banks, 2001 (it explains the basic directions for
establishment of an efficient corporate management system, especially stressing the definition of the rights and responsibilities of the persons involved in the banks’ corporate management system).
8. NBRM Supervisory Circular 1 on the internal control systems, the structure of the internal audit, the role of the external audit and the relationship among the internal audit, the external audit and the banking supervision, 2005
Corporate Governance Code:
9. Corporate Governance Code for Companies Listed on the Macedonian Stock Exchange, 2006 - based on the “comply” or “explain”, the explanation must be included in the annual report and submitted to the country’s stock exchange. The Code is accompanied by the Scorecards for one and two tier companies that are meant for evaluation of the degree of the application of the corporate governance code. However, the application and publishing of the Scorecard is not clear, as there is no mention about the enforceability or use of the Scorecard in any regulation.
5 Information from the Federation of Euro-Asian Stock Exchanges website (http://www.feas.org/Member.cfm?MemberID=16),
accessed on 28/12/2011. 6 Most laws and regulations are available on NBRM webpage, see at: http://www.nbrm.mk/default-
en.asp?ItemID=D4BE1FC21D905E429BF16432CCF609C3 and on the MSE website at: http://www.mse.org.mk/Page.aspx?ContentID=65
FYR Macedonia Country Report – 2012 PAGE 8 of 24
B. Key findings
1) The strategic and governance role of the board
Key strengths
Legal Framework
13. The banking law and banking regulations are well developed, creating sound legislative framework for corporate governance in banks. The law empowers the supervisory board in banks to approve banks’ policies for conducting financial activities and supervise their implementation. The law further details SB responsibilities, which include appointment of senior executives and oversight of their work. Although the company law allow joint-stock companies to be organised either under the one or two-tier system, the banking law requires two-tier governance system for banks.
14. There is a separate mandatory banking regulation on Basic Principles of Corporate Governance in Banks that establishes guiding rules for bank’ governance structure, duties of board members and executives, selection criteria for board members, as well as the obligation for banks to approve a corporate governance code. The regulation incorporates many of the best international corporate governance principles, such as duties of loyalty and care for board members, clear lines of responsibility and authority throughout the bank, and correlation of the remuneration with the bank’s long-term objectives.
Supervisory practice
15. The NBRM has access to most governance documents of regulated entities as well as the authority to address corporate governance failures and compel appropriate remedial action. These include setting a timetable for compliance and deciding on sanctions for non-compliance. Responses to our questionnaires indicate that such powers are occasionally used.
Bank Practice
16. The governance structure in the banks reviewed is based on a two-tier structure that includes supervisory board ('SB') and management board ('MB'). The supervisory board does not include executive members. In line with the legal requirements, the supervisory board appoints the senior executives and monitors their activity.
17. In accordance with the requirements of the regulation on Basic Principles of Corporate Governance in Banks, all reviewed banks have approved their own corporate governance codes detailing banks’ governance structure and governance bodies’ responsibilities. The codes also include the criteria for board members' appointment. Most of the large banks publish their codes on-line. Boards in all banks adopted codes of ethics that inter alia must include requirements in relation to transactions with conflict of interests.
FYR Macedonia Country Report – 2012 PAGE 9 of 24
Key weaknesses
Legal Framework
18. The law does not attribute the approval of the bank strategy and the budget to the supervisory board, which is a key function of the board must have to effectively govern the bank.7 According to the law, the approval of the budget and the strategy is the responsibility of the general meeting of shareholders ('GMS'). In practice, at least one respondent bank has indicated that the final version of the strategy is approved by the GMS. In fully owned subsidiaries, this might not be a problem, but in listed banks, especially those with multiple shareholders, it may encourage the development of two budgets: one to be approved by shareholders and the “real” more confidential budget developed by management.
19. The law prohibits supervisory board members from being part of governance bodies in other banks, thus limiting potential for conflicts of interests. However, such requirement should make an exception for banks in the group. This would explicitly allow directors and executives of the parent/group to sit on local boards and be able to pass on good practices and actively participate in the oversight of the subsidiary. The number of boards on which such representatives may sit should still be limited. Although, in practice banks appear to disregard this provision and have group executives and board members sitting on their subsidiary boards, this legal provision should be straightened out to avoid confusion.
Supervisory practice
20. Two out of the three largest banks in the country, holding together about 40 % of banking sector assets are subsidiaries of foreign banking groups. Bearing this in mind, the local legal framework, supervisory authority and bank practice should attempt to include checks and balances to ensure that subsidiaries do not blindly follow policies and practices of the group. Although the NBRM reports that it meets annually with the representatives of the parent, it does not require disclosure of policies detailing the role of the parent/group in the decision making process of the subsidiary.8 Additionally, there is no legal requirement for the local SB to include members with knowledge of the local market. In practice however, the two largest subsidiaries appear to appoint a number of resident directors unrelated to the group.
Bank Practice
21. All three largest banks in the country are registered with the Macedonian Stock Exchange (MSE) and are subject to the MSE Corporate Governance Code. However, it is sometime difficult to find information on how whether banks comply or not with the MSE Corporate Governance Code.9 One of the banks reviewed informed in its annual report that its GMS adopted a report about its compliance with the MSE Code.10 Bank related corporate governance issues are additionally regulated by a separate regulation for banks: Basic Principles of Corporate Governance in Banks. This, however, should not render ineffective banks obligations under the MSE Code.
7 For further guidance see Principles for enhancing corporate governance by the Basel Committee on Banking Supervision, 2010,
Principle 1, pages 7-8, at: http://www.bis.org/publ/bcbs176.pdf 8 Best practices recommend the parent, in order to fulfil its internal governance responsibilities, to: (a) establish a governance
structure which contributes to the effective oversight of its subsidiaries and takes into account the nature, scale and complexity of the different risks to which the group and its subsidiaries are exposed; (b) approve an internal governance policy at the group level for its subsidiaries, which includes the commitment to meet all applicable governance requirements; (c) ensure that enough resources are available for each subsidiary to meet both group standards and local governance standards; (d) have appropriate means to monitor that each subsidiary complies with all applicable internal governance requirements; and (e) ensure that reporting lines in a group should be clear and transparent, especially where business lines do not match the legal structure of the group. 9 The Code and the Scorecard are available on the MSE website at: http://www.mse.org.mk/Page.aspx?ContentID=65
10 See MSE information about issuers at: http://www.seinet.com.mk/Issuers.aspx
FYR Macedonia Country Report – 2012 PAGE 10 of 24
Key recommendations
Legal framework
1. The law should provide that banks’ boards, not annual general meetings, have the legal responsibility for the adoption of the budget and strategy of the bank.
2. The prohibition on members of the governance bodies of another bank from sitting on the bank's supervisory board should make an exception for parent/group executives and directors sitting in the subsidiary’s board.
Supervisory practice
3. The NBRM should monitor local SB involvement in deciding strategic issues and require banks to submit policies specifying the role of the parent entity in decision-making in specific business and functional areas.
Bank Practice
4. Listed banks’ reporting on their compliance with the MSE Code should be strengthened.
2) Composition and functioning of the board
Key strengths
Legal Framework
22. Banking regulations set “fit and proper” criteria for the management and supervisory board members. The supervisory board members are required to have banking or financial expertise, moral probity and financial soundness. The law also gives a definition of independence of board directors and establishes that at least ¼ of board members must be independent. The definition includes independence from qualified shareholders (i.e. 5% holder of voting rights in the bank).
23. Another positive feature of the banking regulations is the requirement that the supervisory boards and the audit committees must undertake self-assessment of their activity on a collective and on individual basis; the results are notified to the general meeting of shareholders.
24. The banking regulations adequately detail the duties of loyalty and care for the supervisory board members, including the sufficiency of time they should spend for their duties. The banking law also includes sanctions for breach of their duties. At the same time, it does not appear that any such cases reached the courts. To ensure that board members are sufficiently engaged, the law limits the number of other governing bodies on which board members may sit to five companies and no other bank.
Supervisory practice
25. The supervisory authority pre-approves all candidates for the supervisory board and management board and has the power to reject appointments. The NBRM reports that it monitors the expertise of the board members and the leadership abilities of the board chairman, as part of the approval process and during on-site visits. The NBRM also considers the independence of supervisory board members.
FYR Macedonia Country Report – 2012 PAGE 11 of 24
Bank practice
26. The supervisory boards of the three largest banks in FYR Macedonia are of manageable size (see Exhibit 6, below) and, in line with legal requirements, have at least ¼ of independent board members, whose names are disclosed on the banks’ websites. The composition of boards varies but primarily includes members with banking/financial experience. Supervisory boards do not include executive members.
Exhibit 6: Board sizes in the three largest banks in FYR Macedonia and proportion of independent directors
27. Banks reviewed have adopted separate charters for their governing bodies detailing their duties and responsibilities, which are also described in the banks' codes of corporate governance.
28. In line with the law, all banks reviewed have set up audit committees. However, these are not board committees (the downsides of such structure are discussed below in the Internal Control section, below). The Basic Principles of Corporate Governance in Banks do not clearly require banks to create a remuneration committee but on several occasions they mention bank remuneration committees. Accordingly, the banks reviewed have created remuneration committees, and one respondent bank claims to have created a nomination committee (see Exhibit 7, below).
FYR Macedonia Country Report – 2012 PAGE 12 of 24
Exhibit 7: Committees in the two banks reviewed
Audit (separate body) Remuneration Risk Nomination
Bank 1 X
Bank 2 X X
29. All banks' boards reportedly perform self-evaluations on a 6 months basis. Banks also include detailed board members nomination criteria and procedures in their corporate governance codes, which the majority of large banks publish on-line.
Key weaknesses
Legal framework
30. The law requires bank supervisory boards to meet at least once per month. This may be excessive for purely strategic decisions and indicative of boards' implication in operational matters. Accordingly, bank practice shows that in all banks supervisory boards meet every month and in one bank the board met fourteen times last year. On the other hand, although the list of responsibilities of the supervisory board included in the law appears to concentrate on strategic matters, some of the items such as "discussion of reports by state agencies" are too generic in nature and may be interpreted extensively to include operational matters, which should not be attributed to the supervisory board.
31. Two out of the three largest banks in the country are subsidiaries of international banking groups. In a group setting, there is a risk that a subsidiary board may be viewed as mere formality, instances that exist only to justify the “fiction” of the separate legal entity. But it is wrong to view subsidiary boards as devoid of any organisational value. From a group’s perspective a subsidiary board is a very useful “hub “of local accountability, bringing together the oversight of all functions and business lines at local level. The board provides a “mini big picture” of the subsidiary, which helps to avoid vertical silos across the group. When it comes to controls, local boards are a very useful additional buffer, another line of defence, to prevent lapses and failures at local level. From a forward looking strategic perspective, they are also a useful way to provide an out-of the-box perspective on local threats and opportunities which might often elude both local and group executives. Finally, from a regulatory perspective, subsidiary boards ensure that institutions, especially the systemically important ones, are focused in preserving the stability and effectiveness of the local banking system even in the few cases where these priorities might not be aligned with the broader interests of a multinational corporate group.
32. The law and banking regulations do not sufficiently stress the value and role of independent directors. There is no requirement that independent directors sit on board committees or the audit committee. In this respect, independent directors on board committees should have the key role to – among others - ensure an “objective judgement” in delicate decisions, potentials for conflicts of interests, ensure the independence of the internal audit and risk management functions, and in preserving the interests of stakeholders. The Basel Committee recommends the appointment of independent directors to board committees to increase the objectivity of committee decisions.
FYR Macedonia Country Report – 2012 PAGE 13 of 24
Bank practice
33. Banks do not seem to have created a permanent position for company secretary who would assist supervisory board with the flow of information and organisation and with corporate governance issues. The company secretaries assist in improving board effectiveness (especially considering the fact that boards are required to meet monthly) and provide the board with clear information about the corporate governance structure and mechanisms at the bank. 11
34. Banks do not seem to have trainings and induction programs in place for the supervisory board members, which is an important tool to keep directors up to date with banking developments and abreast of bank structure. The Basel Committee recommends that in order to help board members acquire, maintain and deepen their knowledge and skills and to fulfil their responsibilities, the board should ensure that board members have access to programmes of tailored initial (e.g., induction) and ongoing education on relevant issues.12
Key recommendations
Legal framework
1. The legal framework should provide guidance on the role and functions of independent directors (e.g., offering an objective judgement, monitoring potential conflicts of interests and serve as guarantors of independence for the risk and audit functions). As the need for objectivity is higher in board committees, the framework should require that independent directors should be members of the audit committee.
Bank practice
2. Banks should consider appointing a senior company secretary for enhancing the effectiveness of board and committees' work.
3. Banks should consider undertaking training and induction courses for board members.
3) Risk Governance
Key strengths
Legal framework
35. The NBRM has issued a separate Decision on the Risk Management that provides guidance to banks in setting up their risk governance structures. The regulation clearly delegates the strategic decisions regarding risk governance to the supervisory board, which must establish risk limits to be implemented by the senior management. The regulation also requires banks to set up an executive risk management committee comprising senior executives and a separate risk management department.
Supervisory framework
36. The supervisory authority monitors banks’ risk profiles on semi-annual basis and supervises risk governance structure in banks. The NBRM requires a separate statement detailing the banks' risk
11
For guidance on the corporate secretary role and responsibilities, see ICSA Guidance on Corporate Governance Role of the Company Secretary: http://www.icsa.org.uk/assets/files/pdfs/081020%20-%20Corp%20Gov%20role%20of%20co%20sec.pdf 12
See Principles for enhancing corporate governance by the Basel Committee on Banking Supervision, 2010, Principle 2, page 10.
FYR Macedonia Country Report – 2012 PAGE 14 of 24
appetite and respondent banks confirmed that they adopt risk appetite statements. However, based on the answers to questionnaires and the review of the banks' annual reports, we suspect that the risk appetite is akin to strategy rather than “the amount of risk that an organisation is prepared to accept, tolerate, or be exposed to at any point in time”. In our view, it is a key strategic responsibility of the supervisory board to formulate the bank’s risk appetite, which should serve to provide clear top-down guidance to risk originators within the bank’s management as to how far they can go in using the bank’s capital within a determined period of time.13
Bank practice
37. Banks’ supervisory boards are adequately involved in setting up risk management policies and are regularly informed of concentration ratios in specific geographies and sectors that may affect risk policies. In line with banking regulations, banks use stress-tests to decide their policies. However, the supervisory boards do not participate in designing the tests, which may be useful in order for the board to evaluate the way tests reflect the bank's appetite set by the board. Banking regulations require that the results of the tests must be regularly reported to the NBRM.
38. In accordance with banking legal requirements, all banks created an executive risk committee that meets weekly and has an integrated view of all categories of risks and responsibility for the overall risk profile of the bank.14 All banks have also established a credit committee and one bank has an ALCO.15
39. Banks have established separate risk departments in charge of monitoring bank compliance with risk policies, procedures and exposures. In line with the legal requirements, the risk departments primarily report to the executive risk committee. The banks reviewed reported that their risk management function was audited 2-3 times in the last three years by the banks' internal audit function.
Key weaknesses
Legal framework
40. The law and banking regulations do not require banks to appoint an independent chief risk officer with direct access to the supervisory board. In some banks the role of the CRO is delegated to the head of the senior risk committee, who often is the CEO or is cumulated with another role as for example CFO. Best practices recommend large banks to appoint a CRO responsible for the risk management function across the bank and for coordinating the activities of other units relating to the bank’s risk management framework. When the bank’s characteristics – in particular its size, organisation, and the nature of its activities – do not justify entrusting such responsibility to a specially appointed person, the person responsible for internal control can be made responsible for risk management as well. The CRO or equivalent should be able to communicate directly with the management board concerning adverse developments that may not be consistent with the institution’s risk appetite and tolerance and
13
For further guidance about board responsibilities see Basel Committee on Banking Supervision, Principles for enhancing corporate
governance (2010), Principle1, page 7-8; and EBA Guidelines on Internal Governance, (GL 44), 2011, page 8. 14
"Risk reporting systems should be dynamic, comprehensive and accurate, and should draw on a range of underlying assumptions.
Risk monitoring and reporting should occur not only at the disaggregated level (including risk residing in subsidiaries that could be considered significant), but should also be aggregated upward to allow for a firm-wide or consolidated picture of risk exposures. In this regard, organisational “silos” can impede effective sharing of information across a bank and can result in decisions being made in isolation from the rest of the bank. Overcoming information-sharing obstacles posed by silo structures may require the board and senior management to review or rethink established practices in order to encourage greater communication. Some firms have found it useful to create risk management committees - distinct from the board’s risk committee - that draw members from across the firm (e.g., from business lines and the risk management function) to discuss issues related to firm-wide risks.", Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), §§ 97-98, see at: http://www.bis.org/publ/bcbs176.pdf 15
The Asset-Liability Committee (ALCO) is a senior management committee in a bank, responsible for coordinating the institution's
borrowing and lending strategy, and funds acquisition to meet profitability objectives as interest rates change.
FYR Macedonia Country Report – 2012 PAGE 15 of 24
business strategy and be able to report directly to the supervisory board or, where appropriate, to the audit committee (or equivalent).16
Supervisory framework
41. In view of the fact that supervisory boards have the responsibility to decide risk management policies and monitor the risk management function, the supervisory authority should encourage and banks should include risk management expertise on the board or have the capacity to seek independent expert opinion where necessary. It is important that the supervisory authority encourages boards to include an adequate “mix of skills” covering all relevant areas of the bank’s activity. Examples of skills that the board should seek to have (or have access to) include: finance, accounting, bank operations and payment systems, strategic planning, communications, governance, risk management, internal control, bank regulation, auditing and compliance. The board collectively should also have a reasonable understanding of local, regional and, if appropriate, global economic and market forces and of the legal and regulatory environment.17 This would contribute to effective discussions on the board serving as a check on group proposed policies or management decisions.
Key recommendations
Legal framework
1. The law should require the largest banks to appoint a CRO or equivalent senior function responsible for the risk management function across the bank and for coordinating the activities of other units relating to the bank’s risk management framework and direct access to the SB and its independent directors.
Supervisory/Bank practice
2. The supervisory authority should encourage and banks should strive to include risk management expertise on their supervisory boards and be able to access independent expert opinion when necessary.
4) Internal Control
Key strengths
Legal framework
42. Banking regulations comprise a comprehensive internal control framework for banks that demands clear segregation of duties and delegation of authorities. The regulations assign the responsibility for efficient organisation of the internal control systems to the supervisory and management boards. Accordingly, the reviewed banks report that they regularly review the organisational charts and terms of reference for key functions and business lines.
43. The banking regulations require banks to set up independent and efficient internal audit departments. The internal audit function reports directly to the audit committee and supervisory board, where the supervisory board appoints and dismisses the head and other staff of the department.
16
For further guidance, see CEBS, High level principles for risk management (2010), page 4: http://www.eba.europa.eu/documents/Publications/Standards---Guidelines/2010/Risk-management/HighLevelprinciplesonriskmanagement.aspx 17
Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), page 10.
FYR Macedonia Country Report – 2012 PAGE 16 of 24
44. There are rules for conflicts of interests and transactions with related parties that include the requirement for board and senior executives to disclose their interests, fair terms transactions, approval of transactions with conflict of interests and with related parties by the senior management or the supervisory board. The definition of related parties is comprehensive and there is a specific Decision on the Method of Determining Connected Persons/Entities that guides banks in identifying related
parties. Consequently, respondents believe that related parties transactions take generally place under transparent conditions.
45. The law prohibits external auditors to be in conflict of interests with the bank and requires banks to rotate external auditors every three years.
Supervisory practice
46. The supervisory authority is instrumental in monitoring the internal control process and periodically reviews the efficiency of internal audit function in banks. The NBRM assesses the effectiveness of the oversight of the control function by the board during its on-site inspections, as well as the effectiveness of the management information system. Additionally, banks submit to the BNB their policies on conflict of interests and regular reports about all transactions with related parties.
47. The banking regulation requires segregation of duties and clear lines of responsibilities for all departments within the banks. Accordingly, the NBRM monitors the segregation of duties between functions responsible for initiating a transaction; binding the bank; making payments; and accounting for these. It was noted that the law does not clearly explain the concept of “segregation of duties” and the supervisory authority could consider providing some guidance in this respect.18
Bank practice
48. All reviewed banks have set up independent internal audit departments reporting to the supervisory board. The duties and authorities of the audit department, management, audit committee and supervisory board are clearly mapped out and documented. In at least one bank, the internal audit department regularly communicates with the bank’s external auditors.
49. Banks have set up separate compliance departments in charge of monitoring compliance risk.19 The banks reviewed have adopted codes of ethics, which include detailed rules regarding handling transactions with conflict of interests and related parties, or adopt separate policies regarding such transactions.
Key weaknesses
Legal framework
50. Banking regulations require all banks to create an audit committee ('AC'), which is a separate structure that should comprise a majority of SB members, whereas the others must be outside independent
18
Best international practice recommend that as part of procedures to manage conflict of interests, banks should insure "adequate segregation of duties, e.g. entrusting conflicting activities within the chain of transactions or of services to different persons or entrusting supervisory and reporting responsibilities for conflicting activities to different persons". See, EBA Guidelines on Internal Governance (GL 44), page 30 (at: http://www.eba.europa.eu/cebs/media/Publications/Standards%20and%20Guidelines/2011/EBA-BS-2011-116-final-(EBA-Guidelines-on-Internal-Governance)-(2)_1.pdf) and Principles for enhancing corporate governance (2010) by Basel Committee on Banking Supervision, page 24. 19
Compliance risk is defined as the current or prospective risk to earnings and capital arising from violations or non-compliance with laws, rules, regulations, agreements, prescribed practices or ethical standards) can lead to fines, damages and/or the voiding of contracts and can diminish a bank’s reputation. See EBA Guidelines on Internal Governance (GL 44), page 43.
FYR Macedonia Country Report – 2012 PAGE 17 of 24
members. There is no requirement that the independent directors of the supervisory board sit on the audit committee. In practice though, banks appear to include independent directors on their ACs. The inclusion of outsiders (i.e., non supervisory board members) in board committee needs to be carefully assessed.20 The key question here is what could a person that it is not a board member add to the debate? The discussion is open. First, we would argue that “board” committees should include only “board” members if the functions delegated to the committee are typical “board” functions. Secondly, it is essential that those board members sitting in the committee and recommending specific actions to the supervisory board, then follow up such recommendations and vote on the committee’s recommendations at the board, therefore reinforcing their “objective judgement” at the board. Finally, committees that include outsiders might create problems with confidentiality and accountability issues, since such "outsiders" are not bound by duties of loyalty and care applicable to the supervisory board members.
51. The law further requires that audit committees comprise 5 to 9 members and include one qualified auditor. This may cause banks to include outside members in order to satisfy this requirement. While, it is legitimate that the committee might need external advice or expertise on specific issues, the committee should be able to hire such expertise on a consultation basis, but it should not allow the advisor(s) to replace the committee in its determinations and recommendations. Additionally, the size requirement for the audit committee seems excessive. In this respect, it should be noted that all largest banks in the country opted for the minimum number of members.
Supervisory practice
52. The supervisory authority does not seem to monitor the composition of the audit committee and does not pre-approve its outside members. The law includes detailed fit and proper tests for the audit committee members which require knowledge in (i) the bank's operations, its products and services, (ii) the risks the bank is exposed to, (iii) the internal control systems and risk management policies of the bank, and (iv) accounting and audit. However, it is not clear whether the supervisory authority monitors compliance with such requirements. 21
53. It appears that the supervisory authority does not require regular reporting and disclosures about banks' internal control function. The Basel Committee recommends supervisors to ensure that the internal audit function conducts independent, risk-based and effective audits. This includes conducting periodic reviews of the bank’s control functions and of the overall internal controls. Supervisors should assess the adequacy of internal controls that foster sound governance and how well they are being implemented.22
Bank practice
54. As mentioned above in § 32 there is no clear indication on the role of independent directors on the supervisory board. Consequently, it does not seem that independent directors meet separately with
20
The arguments in favour of this approach are that non-board members would allow the audit committee to draw from a larger pool of industry and accounting expertise and that it might give the audit committee greater independence. 21
According to the international guidance on corporate governance, it is advisable that the audit committee consists of a sufficient number of independent non-executive board members. At a minimum, the audit committee as a whole should have recent and relevant experience and should possess a collective balance of skills and expert knowledge commensurate with the complexity of the banking organisation and the duties to be performed - in financial reporting, accounting and auditing. Principles for enhancing corporate governance (2010), Basel Committee on Banking Supervision, Principle 3, page 13 and EBA Guidelines on Internal Governance (GL 44), 2011, page 28. 22
Principles for enhancing corporate governance (2010), Basel Committee on Banking Supervision, page 31, § 138.
FYR Macedonia Country Report – 2012 PAGE 18 of 24
the internal audit department, external auditor, CRO or compliance department in order to insure the independence of these functions.23
55. External auditors appear to provide other than audit services, but banks do not seem to have policies to handle the provision of non-auditing services. Provision of non-audit services by the external auditor can significantly impair its objectivity. The general legal requirement, currently included in the law, that the external auditor of the bank is not in conflict of interests with the bank is helpful, but should be underpinned by a policy detailing the procedures for the engagement and remuneration of the external auditor and the definition of those non-auditing services which should be prohibited because posing a high risk of conflict and auditor independence. 24
Key recommendations
Legal framework
1. Authorities should assess the effectiveness of the current structure of the audit committee and consider if it would be more effective to require banks to create audit committee as a board committee, composed exclusively of supervisory board members, whose majority should be independent from management and controlling shareholders.
Supervisory practice
2. The supervisory authority should monitor the composition and qualification of the audit committee. This monitoring may include pre-approving members of the committee who are not SB members and regularly meeting with members. The NBRM should also require banks to regularly submit internal control reports.
Bank practice
3. Banks should ensure through their internal documentation and policies that independent directors have the opportunity and authority to independently meet with the bank’s control departments.
4. Banks should consider approving policies for handling non-audit services provided by independent auditors in order to avoid potential conflict of interest.
5) Incentives and Remuneration
Key strengths
Legal framework
56. The regulation on Basic Principles of Corporate Governance in Banks requires banks to adopt remuneration policies aligned to the corporate culture, the long-term objectives, strategy, and the control environment of the bank. The supervisory board is in charge of approving the remuneration
23
It may be beneficial for independent members to meet separately, both among themselves and with the relevant control areas, on a regular basis to ensure frank and timely dialogue. In addition, board consideration of risk-related issues may be enhanced by members serving on more than one committee (subject to constraints on members’ time). For example, a member who serves on the compensation committee while also serving on either the risk or audit committee may have a greater appreciation of risk considerations in these areas. See Principles for enhancing corporate governance (2010), Basel Committee on Banking Supervision, Principle 3, page 13-14, § 54. 24
For further guidance see OECD Corporate Governance Principles (2004), p. 55, at: http://www.oecd.org/dataoecd/32/18/31557724.pdf
FYR Macedonia Country Report – 2012 PAGE 19 of 24
policy, which should set clear guidelines for the management when deciding compensations to bank employees. The supervisory board is also in charge of setting the compensation for the members of the management board.
Bank practice
57. In line with legal requirements, the banks reviewed have adopted remuneration policies and their supervisory boards set compensation levels for the executives in accordance with these policies. As prescribed by law, banks disclose in their annual reports the aggregated amounts paid to management.
58. The legal framework does not clearly require banks to establish remuneration committees but mentions such possibility. All banks reviewed appear to create remuneration committees at the supervisory board to assist the board in deciding remuneration issues and develop the remuneration policy. The law indicates that bank remuneration committees should be comprised of independent directors. The composition of bank committees is not clear, as banks do not disclose such information.
Key weaknesses
Supervisory practice
59. The NBRM does not seem aware of the banks' remuneration practices and does not regularly monitor the implementation of bank remuneration policies. The supervisor should keep abreast of bank practices in this area to spot any irregularities in a timely manner. Additionally, the supervisor should encourage banks to link their remuneration practices to prudent risk management.
Bank practice
60. At least in one bank reviewed, between 40-70% of the total compensation to senior executives is variable. The bank recognizes that such variable payments are not necessarily linked to prudent risk management and not deferred. This may create serious risks as shown by the recent financial crisis by encouraging the management to launch into excessive risk taking in order to maximise profits.25
61. Banks reported that their CRO is paid based on the same criteria as other senior management. This may jeopardise the objectivity of the CRO in their views on risk management. According to best international practice: "for employees in the risk and compliance function, remuneration should be determined independently of other business areas and be adequate to attract qualified and experienced staff; performance measures should be based principally on the achievement of the objectives of their functions."26
62. Additionally, according to the corporate governance code of one of the banks reviewed, and the answers to the questionnaire provided by the other, the supervisory board members may be paid a variable fee depending on the profits of the bank. This practice should be carefully reviewed. According to best practices, it is preferable to pay non-executive directors fixed compensation in order to insure their objective approach towards risk and preserve independence of judgement. Incentive-based mechanisms should generally be excluded.27
25
For further guidance on best practice regarding remuneration of senior executives see Compensation Principles and Standards Assessment Methodology, by Basel Committee on Banking Supervision, 2010 at: http://www.bis.org/publ/bcbs166.pdf; and FSB Principles for Sound Compensation Practices, 2009, at: http://www.financialstabilityboard.org/publications/r_090925c.pdf 26
Compensation Principles and Standards Assessment Methodology, Basel, 2010, Principle 3 - Standard 2, see at: http://www.bis.org/publ/bcbs166.pdf 27
Guidelines on Remuneration Policies and Practices (2010), CEBS, page 30, §47, see at: http://www.eba.europa.eu/cebs/media/Publications/Standards%20and%20Guidelines/2010/Remuneration/Guidelines.pdf; see also
FYR Macedonia Country Report – 2012 PAGE 20 of 24
Key recommendations
Legal framework/Bank practice
1. The banking regulations and/or bank practice and policies should require banks to align their compensation practice with prudent risk management. Such measures should include: deferred payment of bonuses and consideration of factors indicating prudent risk management. Additionally, compensation for employees in the risk and compliance functions should be based on separate criteria; and compensation for SB members should be fixed.
Supervisory practice
2. The supervisory authority should monitor the way banks implement their remuneration policies and be aware of the banks' compensation practices.
6) Transparency to the market and regulators
Key strengths
Legal framework
63. The legislation imposes mandatory IFRS based financial reporting for all banks in FYR Macedonia. There is also a dedicated Decision on reports and data disclosure by the banks that establishes a comprehensive framework for transparency of financial information and key corporate governance information, including ownership structure and shareholders information, risk management policies and bank organisational structure.
Supervisory practice
64. The NBRM has full extensive access to bank materials and performs annual on-site inspections. The supervisor feels confident that it can obtain information about the beneficial ownership in banks.
Bank practice
65. The three largest banks in FYR Macedonia appear diligent in complying with current disclosure requirements and publish all required financial information and a fair amount of governance information on their website. This information includes: governance structure of the banks (names of SB, AC, senior management, independent directors, CVs only for senior management though); corporate governance codes (that include description of board responsibilities); charters/bylaws of the bank; related parties transactions disclosures; reports on the activity of the governance bodies in the previous year. Both banks reviewed have a dedicated shareholders’ page with information about the next shareholders’ meetings and some relevant materials. One bank in particular, discloses all GMS decisions, as well as annual reports about the activity of the SB, AC and internal audit department
66. Additional information may be found on MSE web page, such as decisions of the GMS, disclosures of material information affecting issuers' share prices and occasionally reports about the activity of the supervisory boards.
ICGN Non-Executive Director Remuneration Guidelines and Policies, Revised (2009), consultation paper, page 9, at: http://www.icgn.org/files/icgn_main/pdfs/best_practice/exec_remun/2009_guidelines_and_policies_consultation.pdf
FYR Macedonia Country Report – 2012 PAGE 21 of 24
Key weaknesses
Supervisory practice
67. Although the NBRM has full access to all internal documents of the bank, it does not require some key information for effective supervision (e.g., report on risk along the lines required by Basel II, Pillar III enabling a better assessment of their risk profile and their capital adequacy; director remuneration report and report on the effectiveness of internal control system).
Bank practice
68. Banks do not disclose information about supervisory board committees and their composition (e.g., remuneration and nomination committees), education and experience of board members and audit committee members.
69. As mentioned above in § 21, all banks reviewed are listed and should comply with the requirement of the MSE Corporate Governance Code. However, some banks do not disclose in their corporate governance reports how they comply with the Code and do not explain the reason for non compliance.
Key recommendations
Supervisory practice
1. The NBRM should require banks to submit on annual basis a report on risk along the lines required by Basel II, Pillar III enabling a better assessment of the banks’ risk profile and capital adequacy.
2. The supervisory authority should consider strengthening the application and reporting on the MSE Corporate Governance Code by listed banks.
Bank practice
3. Banks should disclose information about the structure and composition of board committees, experience of board and committee members.
FYR Macedonia Country Report – 2012 PAGE 22 of 24
7) Overall assessment of bank governance quality in FYR Macedonia
70. The following table provides a preliminary rating of FYR Macedonia’s performance in the key governance areas mapped out in the EBRD best practice assessment checklist. Rating in this table is subjective and based on the overall assessment of the strengths and weaknesses of the legal framework, supervisory practice and the practice of banks as discussed above. The rating also reflects our assessment of the legal framework, supervisory practice and the practice of banks compared to international best practice standards.28
Issues Score29
The strategic and governance role of the board
Strategic role of the board
Do boards have a sufficiently active role in developing and approving the strategic objectives and the budget of their banks?
Weak
Do boards effectively review and evaluate management performance against agreed budgetary targets?
Moderately Strong
Do boards effectively shape the governance framework and corporate values throughout their organisation?
Moderately Strong
Are boards of subsidiaries in a position to effectively control the operation of their banks? Weak
Is there adequate transfer of good practice between parents and subsidiaries? Moderately
Strong
Board composition and functioning
Size, composition and qualification
Is the size of boards adequate to meet the requirements of their business? Moderately
Strong
Are directors qualified for their position? Moderately
Strong
Is the board sufficiently independent from management and controlling shareholders? Moderately
Strong
Are the duties of directors to their banks, shareholders and stakeholders clearly set out? Moderately
Strong
Is there adequate balance of power between individuals within boards and are there adequate Moderately
28
Best practice standards used in our assessment: Basel Committee on Banking Supervision, Principles for enhancing corporate governance, (2010); Basel Committee on Banking Supervision, Enhancing corporate governance for banking organisations, (2006); EBRD, OECD, Corporate Governance of Banks in Eurasia, (2008); OECD, OECD Principles of Corporate Governance, (2004); European Commission, Corporate governance in financial institutions and remuneration policies, (2010); Institute of International Finance, Final Report of the IIF Committee on Market Best Practices: Principles of Conduct and Best Practice Recommendations, (2008); Netherlands Bankers’ Association, Banking Code, (2009) 29
Where: “Strong to very strong” - The corporate governance framework / practices of supervisory authorities / practices of banks are fit for purpose and are close to best practice. “Moderately strong” - Most parts of the corporate governance framework / practices of supervisory authorities / practices of banks are adequate but further reform is needed “Weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain some elements of good practice but overall the system is in need of reform “Very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain significant risks and are in need of significant reform.
FYR Macedonia Country Report – 2012 PAGE 23 of 24
Issues Score29
checks to maintain the balance? Strong
Do board chairs possess relevant banking and/or financial industry experience and a track record of successful leadership?
Moderately Strong
Do current tenure patterns of board directors suggest a high level of engagement and independence?
Moderately Strong
Do boards provide adequate induction and professional development to their members? Very Weak
Nomination committees
Is the process for director succession and nomination sufficiently transparent? Moderately
Strong
Functioning and evaluation
Are the responsibilities, authorities, and terms of reference of boards and board committees clearly defined and documented?
Moderately Strong
Do boards function in ways that encourage informed contribution and constructive challenge by all directors?
Moderately Strong
Do boards meet regularly? Weak
Are boards and board committees supported by a senior company secretary? Very Weak
Do boards evaluate their performance and discuss the outcome of such evaluation? Moderately
Strong
Risk governance
Risk governance framework
Are boards and their risk committees sufficiently involved in setting the risk appetite and monitoring the risk profile of banks?
Moderately Strong
Do banks appoint and empower senior chief risk officers? Moderately
Strong
Do senior executives have a sufficiently integrated firm-wide perspective on risk? Strong
Risk committees
Are boards in a position to effectively review risk management? Weak
Internal Control
Internal control framework
Does the organisational structure of banks include clearly defined and segregated duties for key officers and effective delegation of authority?
Moderately Strong
Are there enough check s and balances to ensure the independence and integrity of financial reporting?
Weak
Are conflicts of interest including related party transactions effectively managed? Moderately
Strong
Have banks established effective internal audit departments? Moderately
Strong
Do banks establish effective compliance departments to ensure that they comply with regulatory obligations?
Strong
Do boards and their audit committees effectively oversee and regularly review the effectiveness of the internal control systems?
Weak
Audit committee
Do boards establish audit committees? Weak
Are audit committees fully independent? Weak
Do audit committees include at least one member with substantial auditing or accounting Weak
FYR Macedonia Country Report – 2012 PAGE 24 of 24
Issues Score29
experience?
Incentives and compensation
Remuneration policy
Do boards and their remuneration committees have a sufficient role in shaping the compensation system of their banks?
Moderately Strong
Is remuneration meritocratic and linked to firm and individual performance? Weak
Is senior executive compensation aligned with prudent risk management? Very Weak
Remuneration committee
Do boards establish remuneration committees? Moderately
Strong
Are remuneration committees independent from management? Moderately
Strong
Transparency to the market and regulators
External auditor
Is external auditor independence upheld by boards and their audit committees? Weak
Financial statements
Is IFRS required by law or regulation? Strong
Corporate governance
Do banks report regularly on corporate governance matters? Moderately
Strong
Do banks publish key governance information on their website? Moderately
Strong
Is disclosure proportionate to size, complexity, ownership structure and risk profile of banks? Moderately
Strong
Transparency to regulators
Can the supervisory authority obtain information about ultimate ownership and other corporate governance matters?
Moderately Strong