FINANCE, BANKING & GOVERNANCE
It is heartening to note that Republic of Maldives is hosting 7th South Asian Management Forum 2002. The theme is very interesting namely "Towards South Asian Economic Renaissance." This piece looks at Finance, Banking and Governance Areas.
By Prof. Dr. KHAWAJA AMJAD SASED
July 08 - 14, 2002
THE PAPER CONSISTS OF THE FOLLOWING AREAS:
AREA I: FINANCE
AREA II: BANKING
AREA III: GOVERNANCE
THE ABOVE THREE AREAS ARE NOW REVIEWED BELOW:
AREA I: FINANCE
In the wake of globalization of businesses, the function of finance construed within the terminology of "Financial Management" is undergoing significant changes. WTO Regime is expanding. Businesses are becoming global. They need to seek new markets, material, technology, production efficiency and diversification. The shifting emphasis of Financial Management in global perspectives has been captured in the following box:
Box No. 1
Shifting Emphasis of Financial Management in Global Perspectives
Emerged as an independent field of study with focus on legal aspects of formation of new companies and different types of securities for raising finances.
This decade dominated recession in the world. The emphasis shifted to liquidations due to bankruptcies and reorganization of corporate entities and regulation of market securities.
1940s & 1950s
Focus shifted to managerial decisions regarding choice of assets and liabilities.
1960s - 1990s
Emphasis continued covering areas such as valuations, inflationary impact on business decisions, deregulation of financial institutions, diversified financial services, growing use of computers for financial analysis and electronic transfer of information and ever increasing horizons of global markets and business operations.
The following factors are going to dominate the global scene in relation to financial management:
Globalization of business
Increase in the use of Computer Technology
Use of various financial instruments
Excerpts from a speech delivered by the Chairman of Federal Reserve Board of USA, Mr. Alan Greenspan before the Annual Financial Markets Conference of the Federal Reserve Bank of Atlanta, Miami Beach, Florida on February 27, 1998 are as under:
"The Management of systemic risk, of course, is beyond the scope of individual institutions. While interest and currency risk taking, excess leverage and interbank funding represent decisions by individual firms, such decisions, as well as weakness of financial systems, are all encouraged by the existence of a safety net. I believe that what is being referred to as the architecture of the international financial system will need to be thoroughly reviewed and altered as necessary to fit the needs of the new global environment".
Information Technology is having a profound impact on global Financial Management. Some important aspects in this respect are stated below:
I.T.: Financial Decisions
I.T. is revolutionizing the way financial decisions are being made. The impact can be seen in the light of following positive perspectives:
a) Companies have their networks of personal computers linked to one another, to the firm's own mainframe computer and to their customers and suppliers Computers.
b) Financial Managers are able to share information and have "face-to-face" meetings with distant colleagues through video teleconferencing.
c) Access and analysis of data on a real-time basis is enabling quantitative analysis quickly.
d) New generation of financial managers are ornamenting themselves with computer skills and quantitative skills.
Now Software is available for financial analysis. This is enabling financial managers to have quick access to the analyzed data for prompt financial decisions in global dimensions in a prompt manner.
Computer models are available for financial forecasts. This is enabling financial managers to undertake quick project analysis for decision making in global financial decisions.
In the background of above, twelve emerging trends in Global Financial Management which every business must carefully attend in South Asia are now explained below:
Financial Management Linked to Other Disciplines
In Financial Management, several financial decisions are needed to be undertaken. Significant areas are identified in the following box:
Box No. 2
Maior Financial Decisions S.# Areas
Sources of funds
Costs of funds
Capital structure determination
Efficient Working Capital Management
Analysis of Risks and Returns
The dominant goal of financial management is to maximize shareholders wealth. Support to the above finandal decisions is being taken from primary disciplines (accounting, macro and micro economics) and other related disciplines (marketing, production and quantitative methods).
Capital markets are witnessing divestures, hostile take over, new financial instruments, reconstitution of governing boards, computerization of transactions, floorless stock exchanges, strong regulatory frameworks, strengthening democratic accountability of managements by stakeholders, rise of effective corporate governance, Central depository systems, transparency relating to information in respect of fluctuations of listed stock prices, risk management in stock markets, tightening financial discipline, development of ethical codes for jobbers and stock brokers, application of International Accounting Standards (IASs) and Standards on International Standards on Auditing (ISA) - earlier known as International Audit Guidelines, increasing the frequency of disclosure of financial information through quarterly highlights, half yearly financial statements over and above annual financial statements, enforcing voluntary disclosure of financial information in the annual financial statements, greater informative disclosures in financial reports, making mandatory requirements for consolidation of financial statements of holding companies and subsidiary companies, greater awareness of using capital markets for privatizing nationalized enterprises. Vistas in these respects are ever expanding to add to the challenges of finance managers. They ought to develop special skills and acquire a sound and firm grip to deliver the goods in a befitting manner.
Foreign Direct Investment
Foreign Direct Investments (FDI) have been growing. The capital flows have accelerated and now multinational and transnational networks have expanded considerably. This trend will certainly grow and pose challenges to financial managers to move into a phase of international finance managers. The World Development Report 2002 contains pertinent information stating Institutional Credit Rating. This rating enables global finance managers to make sound decisions relating to foreign direct investment in respect of location of FDI.
While deregulation has been increasing in several countries, the traditional set up of registrars joint stock companies, as an extension and attached department of Ministries of Industries of several developing countries, were replaced by quasi autonomous bodies known as Corporate Law Authorities and are now functioning under autonomous Securities and Exchange Authorities. Therefore regulatory frameworks are getting strengthened for a vigilant on watch of Capital Markets. Financial Managers ought to comply with the regulatory framework.
Exchange Rate Fluctuations
Financial managers face lot of challenges to posing problems of fluctuations of foreign exchange rates. Since 1973, foreign exchange rates have been floated and at present most of the countries are following free float concept while some are on managed floating principle. A few have fixed the rates. However, Dollar dominates as an intervention currency, although the rise of Euro is steady and this new currency will take several years to stabilize and expand its usage muscles. The financial managers face the difficult job of financial forecasting due to volatility in foreign exchange rates. The case of Far East starting from 1997 is well known. Rescue packages had to be offered in bigger terms by IMF for Indonesia, South Korea and Thailand. However, Malaysia fixed its rate of exchange and avoided rescue package by not pursuing development projects for US $ 28 billion. Financial Managers in developing countries face the challenge of depreciation of their currencies due to use of US Dollar as Intervention Currency and also due to appreciation of US Dollar against other currencies in which letters of credit need to be opened in other denominated currencies.
At one time only three major rating firms in the United States (Standard & Poors Corporation, generally known as S&P, Moody's Investors Service and Fitch Investor Services) dominated the credit rating agencies scene. Now more agencies on global and national scene are growing. In fact the new trends are that financial institutions, rather than relying on financial and related analysis, are relying greatly on the rating of accredited rating agencies. In this respect it is interesting to note that industrial company rating methodology profile is improving with passage of time. Some of the pertinent areas to develop credit rating rank are included in box No. 3.
Finance Managers are more concerned with non-performing assets. This special attention is bringing out a sharp focus on productive use of assets to achieve greater profitability and efficient use of assets. Special areas identified have been plants not utilized to full capacity and non-performing loans of nationalized and private sector FIs and DFls. Special skills and innovative knowledge backed up with enlightened and forward looking attitudes are surfacing for bejeweling the finance managers to comprehend the issues involved and to achieve the goal of optimal utilization of assets and other financial resources.
Box No. 3
Factors for Credit Rating Rank
Industry Risk Analysis
Issues Industry Position
Evaluation of Management
Protection of Earning
Financial Leverage and Asset Protection
Adequacy of Cash Flow
Financing needs and Plans
Flexibility to accomplish the above
Capital Adequacy Ratios
Concerns have been growing to move towards greater capital adequacy ratio as a financial cushion to banks. As against 7.5% as capital adequacy ratio, the 21st century follows 8.0% and some Middle East countries even are following 11% to 12%. The finance managers ought to guide the top management to move to around 10% as capital adequacy ratio for finandal institution for healthy financial position.
IAS 39 was approved by the IASC board in December 1998 to be effective for financial statements for financial years beginning on or after January 01, 2001.
In June 2000, the IASC Board approved Exposure Board E66 on five limited revisions to IAS 39, Financial Instruments, Recognition and Measurement and related standards. None of the proposed revisions represents a change to a fundamental principle in IAS 39. Instead, the purpose of the proposed changes is primarily to address technical application issues that have been identified following approval of IAS 39 in December, 1998. The Board's assessment is that the proposed changes will assist enterprises preparing to implement IAS 39 for the first time in 2001 and will ensure a consistent application of the Standard.
New Budgeting Techniques
The last quarter of the 20th Century saw the rise of PPBS and ZBB. Now the innovative approach, while translating the benefits from the above two approaches, is output budgeting. The finance managers need to make effective contributions.
Due to competitive trends, several enterprises are undergoing corporate restructuring, corporate sickness is being tackled in two ways. The first one relates to identifying sickness through early warning signaling system. The other one is through institutionalized approach by establishing organizations to diagnose the sick and recommend rehabilitation or liquidation packages. Finance managers ought to play new role in respect of above aspects.
Mergers & Acquisitions
Financial Managers are now accepting challenges of mergers and acquisitions. This global trend is ever expanding and translating the benefits of economy of scales and other related benefits.
Rationale supporting business combinations is supported by several factors explained below:
a) Financial Motivation
Financial motivation has portfolio effect by achieving risk reduction while perhaps maintaining the firm's rate of return.
b) Improved Funding Posture
Improved funding posture is possible as larger firms have access to financial marks.
c) Tax Impact
A favorable tax impact may be available due to carry forward of losses.
There are non-financial management reasons, These generally include the following:
a) Horizontal Integration
This can be facilitated by acquisition of competitors.
b) Vertical Integration
This can be achieved by acquisition of businesses or sellers of goods or services to companies.
AREA II: BANKING
Most of the developed world including USA and Japan have critical difficulties in the area of Banking. Assets and Liabilities Management (ALM) is the area in big trouble. Non-performing loans have been increasing. Sick units continue to attract public criticism. Consequently, financial institutions are suffering a lot. In view of the growing importance of Risk Management and I.T. Applications, the Law of Obsolesce on employees of Financial Institutions is badly affecting their performance. Human Resource Development Frontier needs to be strengthened. A new breed of bankers need to be developed. Moral degradation requires proper attention. Monitoring and Evaluation of projects need to be properly addressed as a serious agenda. Spread needs to be reduced and burden also should be minimized after a careful analysis of Spread and Burden of Financiai Institutions. Capital Adequacy Ratio should be raised beyond the recommended 8%. New products need to be innovated considering the emerging needs of the depositors and borrowers. The Financial Institutions should seriously address the issue of extending advances and loans to SME Sector. Accountability of bad decisions, particularly in terms of lending decisions should be identified.
The above points represent a serious agenda for discussion for SAARC Countries. Research should be initiated and steps should be taken to ensure that banking sector performs well for the prosperity on a wider spectrum rather than serving selected few as vested interest.
AREA III: GOVERNANCE
Good Governance at the Government's level is the crying need of today. However, sound corporate governance at the corporate level is the need of the hour in SAARC Countries. This portion deals with the following aspects:
1. Concept of Corporate Governance
2. Sample Countries of Asia reflecting experiences of Hong Kong and Malaysia.
3. Sharing of recommendations of two UK Committee Reports (Cadbury Committee and Hampel Committee)
4. Twelve points suggested Code of Ethics for South Asia
The above aspects are now reviewed below:
Concept of Corporate Governance
OECD has defined Corporate Governance as under: "Corporate Governance comprehends that structure of relationship and corresponding responsibilities among a core group consisting of:
designed to best foster the competitive performance required to achieve the Corporation's primary objective".
a) HONG KONG
Two Countries have been sampled out to review good corporate governance practices. These include Hong Kong and Malaysia. Based on two reports of the working group on corporate governance published in December 1995 and January 1997 by the Hong Kong Society of Accountants, salient features of the Code for effective corporate governance are summed up as under:
i) Compliance matters should be identified.
ii) Same family must not have more than 50% members of Board of Directors.
iii) There should be a CFO (Chief Financial Officer) through a mandatory provision. iv) Attendance record of Board at AGM should be maintained.
v) Four board meetings must be held every year. However, six meetings are preferred.
vi) Other fees paid to auditors should be separately disclosed.
vii) There should be separate disclosure regarding corporate governance in the annual report of the company.
viii) An Audit Committee, with defined functions, should be established.
ix) Interim reports containing balance sheet, income statement and cash flow should be released.
x) The above interim reports should be reviewed by auditors.
b) MALAYSIA .
Two separate Codes of Ethics for Directors and Secretary of the Company have been developed and published by Registry of Companies, Malaysia.
a) UNITED KINGDOM
Two Committees namely Cadbury Committee (1991) and Hampel Committee (1995) have done a very useful work. Salient features of recommendations of these Committees are summarized below:
i) Cadbury Committee
Four areas were identified for significant improvements. These included Board of Directors, Non-Executive Directors, Executive Directors and Reporting & Controls. In respect of Board of Directors, it was recommended that meetings of Board of Directors should be regularly held, the board must retain full and effective control over the company, it must monitor the executive development, no one individual be given unfettered power, a balance be maintained between power and authority, non-executive directors having sufficient caliber and number be included in the board of directors, direction and control of the company should be firmly in their hand, independent professional advice at company's expense be obtained for furtherance of their duties and for getting benefits from the Secretary of the board and enabling him to stay independent, guidelines included access to advice and services, procedure, rules and regulations should be complied with and board as a whole should examine the question of removal of secretary.
Two basic aspects governing non-executive directors included the extension of their role to contribute towards independent judgment together with areas of contributions to include strategy performance, key appointments and standard of conduct. To ensure that fairness and independence. are achieved, guidelines included: enjoying independent status away from pressure of management, fees reflecting the time which they commit to the company, appointment for specified terms and selection through a formal process. Board as a whole must make the above decisions.
In respect of executive director recommendations included three year contract with shareholders approval, transparent disclosure of directors and chairman's total emoluments with identification of amounts to be paid under major headings, disclosure of salary and performance related elements separately including the basis on which performance is measured, setting up a remuneration committee to recommend the pay of the executive director. The committee must be made up wholly or mainly of non-executive directors. Four major recommendations regarding Reporting and Controls included acceptance by the Board its duty to present a balanced and understandable assessment of the company's position, maintaining an objective and professional balance between Board and internal and external auditors, set up an audit committee of at least three non-executive directors with terms of reference to be in writing and clearly dealing with its authority and duties and reporting by the directors on the effectiveness of the company's system of internal control.
ii) Hampel Committee
The Committee devoted two years (1995-1997) and released their report in January 1998. Summary of conclusions and recommendations covered seven aspects namely, principles of corporate governance, applications of the principles, the future, directors, directors' remuneration, shareholders and the AGM.
Twelve Points Suggested Code of Ethics for South Asia
1. Code of Ethics should be developed separately for;
b) Company Secretary
2. Issuance of quarterly audited financial reports should be made mandatory.
3. A minimum of four meetings of Board of Directors should be held in a year and salient features of decisions made in the above meetings should be circulated to members of the Company as part of transparency.
4. Every listed company must employee a CFO who should be either Chartered Aceountant or Cost & Management Accountant.
5. Board of Directors should address strategic issue.
6. Frequency of board meetings be increased.
7. Audit Committee, with defined functions, must be constituted at least in every listed company.
8. Appropriate training be given to Board of Directors to enable them to play a productive and meaningful role.
9. Non-executive directors should be independent and fair in judgment. Their tenure must not exceed three years.
10. Separate section relating to Corporate Governance should be included in the annual report of the company.
11. The above recommendations must be included in the listing requirements of the stock exchanges of the SAARC Countries.
12. Where there is a need to reflect the above suggestions to be included in the respective company legislation of SAARC Countries, steps be initiated to get the amendments approved.
This article contains enough food for thought. It is high time that issues identified are seriously addressed as an agenda for the first decade of 21st Century to accelerate socio-economic growth, ensure social stability and usher in an era of prosperity and happiness for the over one billion people living in SAARC Countries.