The economic crisis has produced significant social costs in terms of rising unemployment, personal savings diminishing, and loss of trust in financial institutions and regulators. Its effects have spread to the Arab region, impacting different countries, cities, and companies.
How did this happen? The crisis is the result of several failures, but ultimately they come down to a failure of governance systems and ethics, both at the corporate level and at the institutional level.
Writing about good governance as a financial institution at this time is both a humbling and daunting task. But now is also the time to consider what went wrong, what needs to be done to address it, and how we can assure those changes will be successfully implemented. A recovery requires an improved system, in which people can better trust.
Corporate governance
Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation is directed, administered or controlled. It provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance. It includes the relationships among the many stakeholders and the goals for which the corporation is governed. As we now know, the appearance of good governance does not ensure its reality. Part of the challenge we now all face is that those countries and companies assumed to have some of the highest standards of governance are precisely those that have failed worst. The basic principles of good governance include rule of law, ethics, integrity, disclosure, transparency, accountability, not only to shareholders but to all stakeholders. The current crisis has shown that there were implementation problems at least in four areas of governance: board practices, risk management, remuneration and the exercise of shareholder rights. Our challenge now is to learn from past mistakes and shape an enhanced international and regional governance system. Four important opportunities follow.
1. Adherence to standards
As a starting point at the regional level, we should aim to meet the highest international standards such as the recommendations of the Organisation for Economic Cooperation and Development (OECD). While many of the worst offenders of the financial crisis may have professed to be using these standards, it is in most cases a failed application of the standards rather than the quality of the standards themselves. These are a good starting point and companies such as NCB have found them to be of significant value having systematically integrated them over the past several years. At the same time, the bank continuously reviews these recommendations and focuses on means to ensure their implementation.
In Saudi Arabia, the Saudi Arabian Monetary Agency (SAMA), the Kingdom’s central bank and the banking supervisory authority, has played a leading role in strengthening governance in the banking industry on issues such as compliance with the International Financial Reporting Standards, anti-money laundering and combating terrorism financing and fraud.
2. Sustainability and corporate governance
As we urgently seek solutions to the crisis, we need to simultaneously take into account a wider set of pressing economic, social and environmental risks that potentially have similar or greater impact on the global system over the medium to longer-term. If we do not, we may find ourselves in an even worse position soon. Leading businesses around the world are adopting sustainability management – the integrated management of economic, environmental and social performance for the purpose of enhancing value for both shareholders and society (ie all stakeholders). The underlying premise of sustainability management is that companies who can better identify, understand, and respond to a wider range of material economic, environmental and social risks and opportunities will outcompete those companies who do not. This will be especially true as social and environmental trends continue to strengthen.
As part of sustainability management, the ultimate oversight of risks and opportunities relating to these wider issues must be specifically assigned at the board level.
3. Benefits of Islamic Finance
The crisis was triggered by excess leverage, by the complexity of financial products, and by a neglect of risk that was thought to be spread throughout the system via new financial instruments.
Islamic banks seem to have been less affected by the crisis than their western counterparts, very likely because they have been more conservative, mostly due to Shariah Law regulations, which restricted debt transactions or investments in toxic assets.
According to research by Standard & Poor’s Ratings Services, Gulf Islamic financial institutions are being less impacted than conventional financial institutions. These preliminary findings are relevant both regionally and globally. Regionally, the banking sector is not under obligation to be Shariah compliant. Both Islamic and conventional institutions are permitted to operate and are regulated by the same regulatory framework. Shariah supervisory boards are usually put in place by Islamic banks.
On a global level, these findings demonstrate that discussion is warranted over the merits of the practices of Islamic banking and how those practices might inform international reforms.
4. Government policy
When practiced properly by large numbers of companies, good governance can enhance the attractiveness, effectiveness, and competitiveness of national markets. Good corporate governance that incorporates sustainability should therefore further strengthen national markets. Several governments in the region are already exploring this link under the banner of Responsible Competitiveness. These countries include Jordan, Egypt and Saudi Arabia. In Saudi Arabia, the leadership has recognised that this has the potential to contribute significantly to Saudi’s ambition of becoming one of the top ten most competitive nations by 2010. As such, they have launched the Saudi Arabia Responsible Competitiveness Index, an initiative that explores the take-up of sustainable business practices by 40 companies and the correlation to national competitiveness. Other countries in the region should also be encouraged to consider the link between widespread uptake of good governance, sustainability management, and national competitiveness, and to modify government policy and regulatory frameworks accordingly.
Beyond policy and regulatory revisions that will undoubtedly arise, governments have another major opportunity to promote sustainability-oriented governance. Most governments worldwide have not taken into account a long-term sustainability-oriented perspective of fully considered economic, environmental and social development. This has included embracing an economic model that is now understood to not adequately account for negative environmental and social impacts.
As the slowdown hits the region, governments are expected to step in with stimulus of major projects. For example, Saudi Arabia is expected to invest USD 400bn in national projects over the coming five years. For all regional investment, there is an opportunity to achieve immediate progress in factoring the wider range of risks into these projects, so that we can implement projects which contribute to stability over the long-term.
Towards responsible competitiveness
Now is the time to rebuild governance models and focus on rebuilding confidence. While we can start with the best elements of existing models, there is an opportunity to consider the merits of Islamic banking practices and to incorporate sustainability-oriented risk and opportunity oversight at the corporate governance level.
We can collectively contribute to greater competitiveness – a more responsible competitiveness – that leads us to a more prosperous and sustainable tomorrow.
For more information visit the Sustainability section at www.alahli.com
