Poor corporate governance obstructs the financial flow, from multinationals to SMEs and from labourers to multi-millionaires. For an SME, good corporate governance in the banking system enables business growth, points out Mark Fisher.
Corporate governance failures have struck in many industries, with disastrous consequences for those affected. Spectacular examples in recent years include Enron, an energy company that collapsed in 2001, and WorldCom, a telecoms giant that went belly-up in 2002. Lax oversight and inadequate compliance controls at both US companies enabled financial malpractice to flourish. Shareholders lost money and much hand-wringing ensured, leading to the strict – some would say over-zealous – tightening of corporate governance legislation known as Sarbanes-Oxley.
Significant as these cases were, they did not lead to systemic difficulties for the wider economy. The fallout was contained. But when financial problems devastated US and European banks after 2007, beginning with the implosion of Lehman, the impact was felt well beyond the banks themselves. The entire global economic system was threatened as companies in many industry sectors around the world lost confidence in the future and in some cases collapsed, or struggled to survive. The reason was that finance is the lifeblood of all economic activity and when it stops flowing everyone suffers, from multinationals to SMEs and from labourers to multi-millionaires.
Though the reasons for the global financial economic crisis were many and varied, poor corporate governance lay at the heart of the matter. Not only in the sense of leading to illegal activities, but also in the wider sense of enabling incompetence and poor-decision making. Governments, regulators and banks themselves have since taken steps to clean out the stable. Many of these centre around the ideas underpinning ‘Basel 111′, which is a global voluntary regulatory standard that aims to improve bank capital adequacy, stress testing and market liquidity risk. Efforts have also been made to move away from a culture of short-term thinking in financial institutions, based on their most recent financial statements and share price, towards a longer term focus on a sustainable business model. Measures have also been taken to curb high bonuses for bank employees, seen by many people as leading to unnecessary risk-taking. Action taken in the UAE includes a cap on the amount of credit that domestic banks can extend to government-related entities, as well as a possible review by the authorities of the framework of lending by banks against shares.
Such measures are designed to have a positive impact not only on the banks themselves but also on the banks’ customers and clients, and through them on overall economic activity. Globally, the aim is to restore trust and confidence in the banking system through genuine and substantial reforms, so that a financial crisis on the scale of the one that began in 2007 can never occur again. Time will tell whether this is indeed the case, but it is clear that economic activity has staged a revival and the banking system is again performing its central role of enabling businesses to prosper. The UAE is one of many economies where this is evident.
For an SME, the importance of good corporate governance in the banking system leads to an interesting role reversal. SMEs are accustomed to having their own corporate governance questioned by banks, which often closely assess the quality of leadership at a business and the veracity of its accounts before they will extend a loan. Equally, SMEs would do well to assess the corporate governance of a bank before entering into a close relationship with it. A well run bank is more likely to be profitable and therefore able to grant a loan at competitive rates than a poorly run one. It is also likely to employ better loan officers who operate to more efficient standards. And it is less likely to run into financial problems that would reduce its ability to make new loans to its customers.
Hopefully the painful corporate governance lessons of the global financial crisis have been learned. If so both the banks and their customers will be the stronger for it.