CBK Prudential guidelines on independent directors

July 2, 2012

Bryan Marsal was in his living room watching a Giants football game the night of September 14, 2008 when the phone rang. On the other end of the line was the board of directors at Lehman Brothers. The reason for the call: would the co-head of turnaround firm Alvarez & Marsal would be willing to take on the job of taking the firm through bankruptcy? The Federal Reserve had already refused to bail out the bank as it had done for Bear Stearns and the end was near.
“My first question was ‘how much planning have you done?’”
“‘You’re it,’ they told me.”
The next question: “How much cash do you have?” “None.”
“How much time do I have?” “Two hours.”
Despite the ugly situation Marsal said he’d take the job as chief restructuring officer of Lehman Brothers Holdings Inc, and just a few hours later, at about 2 a.m. on Sept. 15 Lehman Brothers filed for bankruptcy. A member of the audience at this week’s event asked if there was some way Lehman’s board of directors could have headed this off, or if there weren’t other signals that this was going to occur.
“Corporate governance is a joke,” Marsal said. “To spend four or five days a year at a company [as board members often do] …. and really believe you can know what is going on with that company is suspect.”
Boards of directors are more useful at giving advice to executives and guidance, but the notion they can really serve as watch dogs and know the workings of a firm and its risks is unrealistic.
But once there is a problem good boards act decisively and aggressively. Despite the awful start to Lehman’s bankruptcy Marsal said the board has since “really earned their money.”
(Extracted from business blogger Tom Fowler’s blog)

The Central Bank of Kenya (CBK) has published a new set of Prudential Guidelines that will be taking effect from August 2012. A key precept of the new guidelines is the rule defining Independent Non-Executive Directors (INEDs). As with any new law, the first question a legislative drafter asks is “what is the mischief we are trying to cure?” The mischief that the CBK is trying to cure is undue influence of majority shareholders within bank boards. The prudential guidelines require that the minimum size of a bank board should be five directors of which the CEO should be one. Three fifths of the members should be non-executive directors. So let me use a practical example here. Assuming Bank XYZ has a board with ten directors; six of them have to be non-executive. Great, we have room for a CEO and three of his executive team.
The prudential guidelines then provide that of the six non-executive directors, the majority has to be independent. So we have four out of the six non-execs as independent. This is where it gets interesting. The guidelines define what “Independence” means which definitions are pretty straightforward and self -explanatory. The seventh definition begs some indulgent retrospection. It defines an independent director as one who is not a direct or indirect representative of a shareholder who has the ability to control or significantly influence management or the board.

Board appointments are a tedious process beginning with the nominations committee identifying a candidate, raking them through the coals in a semi-traumatic due diligence process, submitting the names to the larger board for approval and then ratification at an AGM. That of course is what is supposed to typically happen. What often happens is that members of the nominations committee tee off, have a good round of golf and by the sixth hole have pretty much decided which of their buddies is taking the vacant non-executive director slot. But how does the outside world determine if this INED is a direct or indirect shareholder representative? If Bank XYZ receives a formal letter from the shareholder asking for said person to be appointed to the board to “represent my interests” then this person would be a non-executive director and take up one of the two slots in the above mentioned example. This is because while banks are regulated institutions, they are also incorporated as companies under the Companies Act, Cap 486, which Act enables a company to describe the constitution of its board within its Articles of Association. So if Bank XYZ’s Articles of Association state that the majority shareholder will have the right to appoint at least two fifths of the board members, he can well appoint the CEO, CFO and two non-exec positions and still be within the prudential guidelines.

But if there is no formal appointment, no visible blood or marital relationship, then how is one visibly perceived to be representing direct or indirect interests of the shareholder? The same Articles of Association describe how directors are to be appointed to the board. The appointing authority is the shareholders, through election and ratification at the annual general meeting. Hence if an individual has been elected as a director at the AGM, then that individual owes allegiance and duty of care to the collective shareholder body and not just to specific shareholders. It matters not whether the words non-executive director or independent non-executive director are stitched in bright yellow thread onto their briefcase or handbag. The fact is that they are jointly and severally liable to the shareholders for the actions of management. Sadly very few directors are aware of the severity of their liabilities and responsibilities and frankly speaking, the mischief that should be cured is lack of awareness on the part of directors and stiffer individual and personal penalties for bank boards that allow their institutions to breach regulatory requirements. You can neither legislate good behavior nor can you legislate integrity. What you can legislate are consequences for lack of either. The result is a body of bank directors in the country that are in it to win it and who know that their reputations will be hung, drawn and quartered if their institutions go down. It then speaks to the need to recruit bank directors that completely understand operational and credit risk, asset and liability management and robust loss provisioning. It speaks to the need to have continuous training on the same and regular assessment of the directors’ capacity to oversee those aspects. It therefore begs the question: should we focus on quality of directors or quantity of independents? Trust me, shareholder buddy or not, it will be a tenacious individual who agrees to put their John Hancock next to the words director (independent or not) of a bank.
[email protected]

RELATED

Parasites at the Harvest

March 20, 2024 Musings

Stay In Your Lane

February 27, 2024 Musings

Business and Economy Class Shareholding

October 23, 2023 Musings

Contacts

Carol Musyoka Consulting Limited,
A5 Argwings Court,
Argwings Kodhek Road,
Kilimani.
P.O Box 6471-00200
Nairobi, Kenya.
Office Tel: +254 (0)777 124 002
Email: [email protected]

Follow Us

Subscribe to Newsletter