DFIs to finally be held to higher corporate governance

This article first appeared in The Edge Malaysia Weekly, on September 2, 2019 - September 08, 2019.

Bank Negara has issued an exposure draft outlining proposals for enhancements to the corporate governance requirements for DFIs. Photo by Mohd Shahrin Yahya/The Edge

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DEVELOPMENT financial institutions (DFIs), under increased scrutiny after recent scandals at Bank Pembangunan Malaysia Bhd and Bank Kerjasama Rakyat Malaysia Bhd (Bank Rakyat), will finally be held to higher corporate governance (CG) standards than in the past.

Bank Negara Malaysia is set to impose similar CG requirements on DFIs as it had for banks a few years ago.

On Aug 23, the central bank issued an exposure draft outlining proposals for enhancements to the CG requirements for DFIs. These relate to the composition of boards and directors’ responsibilities, in particular.

Among others, it is now clearly stated that DFIs cannot have active politicians on their boards. Also, a board must have a majority of independent directors at all times. (A quick check reveals that Bank Rakyat and Bank Pembangunan already meet this requirement.)

DFIs have been given a month to provide their feedback.

Most of the proposals set out by Bank Negara are similar to those prescribed for financial institutions in 2016.

Industry sources say it was about time the same requirements were extended to DFIs. This is because DFIs are seen to have lax CG standards and practices in comparison with commercial banks, despite many of them now carrying out the same businesses as the latter.

“It’s the right thing to do. Personally, I think DFIs need to be held to an even higher level of governance [than commercial banks] because they operate with public money — in the sense that the government’s money is public money,” the CEO of a commercial bank, who declined to be named, tells The Edge.

He points out that many of the DFIs have, over the years, ventured into the same businesses that commercial banks are in — Bank Rakyat, for example, does home and corporate financing — and, hence, should abide by the same rules as commercial banks, including on CG requirements.

“It’s important to have a level playing field … to ensure people don’t take advantage of the gaps,” an Islamic bank CEO remarks.

Bank Negara’s enhanced CG requirements will apply to DFIs that fall under the Development Financial Institutions Act 2002 (DFIA), namely Bank Pembangunan, Bank Rakyat, Bank Simpanan Malaysia Bhd, Agrobank, SME Bank and EXIM Bank.

It is worth noting that DFIs like Malaysian Industrial Development Finance Bhd (MIDF) and Lembaga Tabung Haji (TH) do not fall under the Act.

 

The proposals

Under the new requirements, there are stronger expectations of directors’ oversight responsibilities, stricter rules on board composition and more accountability from senior management.

“The board should have the competence, confidence and objectivity to challenge senior management and hold it to account. Accordingly, this policy document sets out strengthened expectations on directors’ oversight responsibilities and the composition of the board. This is expected to be demonstrated through evidence of effective challenge by the board, particularly in relation to key strategic decisions, including material exposures of the DFI.

“In turn, senior management is responsible and accountable for the sound and prudent day-to-day management of the DFI in accordance with the direction of the board,” Bank Negara says in the exposure draft.

One of the more interesting of Bank Negara’s proposals relates to the non-independent and non-executive director that represents the interests of a stakeholder ministry on the DFI board.

Bank Negara makes it clear that such directors have a duty to the bank first, in the event of any conflict. “In the event of any conflict between his duty to act in the best interest of the DFI and his duty to the stakeholder ministry which he is representing, his duty to the DFI will prevail,” it says.

This is to ensure the board is not forced to take directives from specific ministers or authorities, sources say. “You must hold the board accountable, but at the same time let it have the liberty to make decisions in the best interests of the bank and not come under any undue influence from [others],” the earlier CEO says.

Interestingly, this requirement is consistent with the Minister of Finance Inc’s guidelines, “Garis Panduan Ahli Lembaga Pengarah Lantikan Menteri Kewangan (Diperbadankan)”, issued in December 2014, which outlines the duties and responsibilities of the stakeholder ministry representative on the boards of government-linked companies, including DFIs.

Among the other proposals set out by Bank Negara are:

•     A DFI must have at least three directors (excluding executive directors) with finance-related or accounting experience.

•     A DFI must notify Bank Negara before the removal or resignation of an independent director, and must include reasons for the action. The removal or resignation cannot take effect unless the central bank communicates to the DFI that it has no objection.

•     The chairman of the board must not be an executive and must not have served as a CEO of the DFI in the past five years.

•     The tenure of an independent director should generally not exceed nine years.

•     A DFI must adopt a Code of Ethics and the board has to ensure that it provides for declarations of assets by the chairman, directors and CEO, among others.

•    A substantial shareholder and stakeholder, including their representatives and appointees, must not hold a senior management position at the DFI.

•    A DFI must have a CEO at all times.

 

Most of the requirements are not new to the DFIs as Bank Negara has already pointed them in that direction over the last few years.

Unlike normal banks, DFIs are specialised financial institutions set up by the government with a specific mandate to develop and promote key sectors that are considered important to the overall development objectives of the country.

They essentially provide a “national service”, but at the same time, are under pressure to show profit, which is why some have ventured into the commercial banks’ territory, bankers say.

Observers say lapses in CG are probably what led to the recent scandals at DFIs.

Last year, Bank Pembangunan was hit by accusations of bad investment decisions and dubious lending practices. The bank is now cleaning up its books under a revamped board.

And in 2016, Bank Rakyat, the country’s largest DFI, was thrust into the limelight following allegations of corruption involving its then chairman Tan Sri Abdul Aziz Zainal and managing director Datuk Mustafha Abd Razak.

Mustafha was alleged to have committed criminal breach of trust of the bank’s marketing expenditure allocation that was entrusted to him, involving almost RM15 million, while Abdul Aziz was alleged to have abetted him.

The case went to court, and in June last year, both were acquitted and discharged after new developments emerged, which resulted in the prosecution withdrawing its charges against them.

 

 

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