Corporate Governance of Banks in Asia - Joseph Fan

8/2/2019 Corporate Governance of Banks in Asia - Joseph Fan

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The 2005 Asian Roundtable on Corporate GovernanceTask For ce on Cor po r a t e Gov ern ance o f Bank s in As ia

Joseph Fan

Centre for Institutions and GovernanceChinese University of Hong Kong

Session 1Corporate Governance of Banks in Asia

Bali, Indonesia8-9 September 2005

The views expressed in this presentation are those of the author and do not necessarily represent the opinions

of the OECD or its Member countries or the World Bank



2

Outline The landscape of Asian bank ownership

The governance traits of Asian banks

Family controlled banks

State controlled banks Public governance and bank governance

Bank governance and corporate finance

Conclusions



3

0.41

0.16

0.12

0.31

0

0.05

0.1

0.15

0.2

0.25

0.3

0.350.4

0.45

% o

f T o t a l B a n k s

Who Control the Banks? (Pre-Crisis)

Family-Controlled

State-Controlled

Foreigner-Controlled

Others

0.29

0.22

0.26

0.23

0

0.05

0.1

0.15

0.2

0.25

0.3

% o

f T o t a l B a n k s

Who Control the Banks? (Post-Crisis)

Family-Controlled

State-Controlled

Foreigner-Controlled

Others



Corporate Governance characteristics

of Asian Banks

Below we report basic corporate governance

characteristics of banks in 7 Asian economies(Hong Kong, Indonesia, Korea, Malaysia, thePhilippines, Singapore and Thailand)

Be warned: a few other important factors thatinfluence governance quality are not included Reputation

Regulatory oversight of the industry (substitute or

complement?) Competition

• Takeovers and product market competition



Governance Characteristic (Pooled Samples)

83.33

77.08

71.13

62.89

49.4852.58

50.52

29.9

0

10

20

30

40

50

60

70

80

90

% o

f T o t a l B

a n k s

Auditor is a Big-four firm

Chairman is not the CEO

Chairman/CEO is non-

politically connected

Chairman/CEO is a

professional

Small board

More professional

independent directors

Less politically connected

independent directors

Independent directors

dominate the board



6

Governance Score (By Ownership Type)

4.46

4.55

5

5.14

4 4.2 4.4 4.6 4.8 5 5.2

Family controlled

State controlled

Foreigner

controlled

Others



7

Bank Ownership and

Governance Characteristics The banks’ corporate governance characteristics

are in line with their ownership and controlstructures Diffusely owned banks and foreigner controlled banks

adopt outside investor friendly governance structures:• more independent boards,

• smaller boards,

• fewer politicians on boards,

• more separating function between chairman and CEO

• More professional bank leadership

The reverse is true for state or family controlled banks



8

Bank Ownership and

Governance Characteristics Banks with different types of ownership and

control structures are likely to have differentbusiness and financing models: Family and state banks – more relationship based

banking and less dependent on equity financing

Foreigner controlled and widely-held banks – morearm’s-length banking and more dependent on outsidecapital

Because of the differences in business andfinancing models between the two classes of banks, the governance structures of the twotypes of banks are likely different



9

Bank Governance and

Performance No strong evidence that Asian bank

efficiency and performance is related topoor corporate governance Assuming that the banks’ governance

structures are chosen to adapt to theirbusiness environments, the lack of relation iswhat we should find

However, significant relations between

bank performance and governance existin a few sub-samples. More analysis is needed to find out the

explanations for the relations.



10

Bank Governance and

Performance No strong evidence that Asian bank

efficiency and performance is related tothe corporate governance score

Assuming that the banks’ governancemodels are chosen to adapt to theirbusiness environments, the lack of relation is what we should find

In the following, we discuss thegovernance models of Asian banks,focusing on family and state owned banks



11

Family Owned Banks

Trait

Relationship based banking

Focusing on a region or a community

Advantages

High incentive to maximize profit and

manage risk Strong social network and local

knowledge



12

Governance Advantages of

Family Owned Banks Strong internal governance (through

family codes and back-end loadedcompensation structure) and external

governance of contractual relationshipsthrough family reputation, both provideprivate enforcement that is particularly

important in weak legal environmentwhere public enforcement is weak



13

Governance problems of family-owned

banks

Concentrated ownership exacerbate

financial leverage and the associatedagency problems with depositors,creditors, and minority shareholders

Lower professionalism

Uncertainty in family succession

Intensive related party transactionsassociated with group and diversifiedbusiness structures



14

Liu’s Holdings Ltd. Liu’s Family Other Investors

45.33% 16.53% 38.14%

Liu Chong Hing Investment Limited

LCH

Insurance

LCH Property

Management and

Agency

100%100% 100%

LCH Estate

Company

60%

Guangzhou

Chong Hing

Property Dev.

Other

subsidiaries

100%

Liu Chong Hing Bank Ltd.

45.11% 20%

COSCO

Pacific

Other

Investors

23.55%9.66%

Bank of Tokyo-Mitsubishi Liu’s

Family

1.68%

A Case in Point:

Liu Chong Hing Bank (HK)



15

A Case in Point:

Liu Chong Hing Bank (HK) Most of the service of LCHB is provided for the

group! 88% of the revenue in banking segment is

from internal-segment sales 70% of the assets in banking segment are

investments in associates. The bank has been performing quite well Note that related party lending is not limited to

banks and certainly not family banks. It isgenerally popular among non-bankconglomerates



16

Family Owned Banks Related party transactions (loans and

investment) Normal as the business is relationship based Side effect – can be abused by controlling owners

How do family firms mitigate the conflict? Family reputation Reputation may not contain holdup problem in crisis or

ownership transition (succession)

What regulation is needed? Not much as family firms have incentives to deal with

most of the issues during normal time Firewall between bank and other non-bank family

businesses to prevent conflicts in abnormal situations



17

Government Owned Banks Trait

Multiple objectives, not just profitmaximization

Bureaucratic, low efficiency Corruption and bank scandals

Advantage Social interests (?) Deep pocket



18

The governance issues of

state owned banks Weak incentives of bank managers

Lack of ownership Rigid compensation structures

Methods of mitigating conflicts

Bureaucratic rules

Monitoring and supervision

The state’s incentive of monitoring is weakenedby their own conflicts of interest Politicians and bureaucrats are not the true owners of

the banks

Dual role of bank regulator and operator

Vulnerable to weak public governance



19

Public Sector Governance

and Bank Governance Social or private interest?

Academic research show little support for theview that government banks facilitateeconomic development

Abundant evidence that politicians use banksto channel funds to their favored firms orsupporters

Non-preferred borrowers need additionalpayment to establish banking relationships

Excessive crony and policy lending may haveexplained why corporate sector debt is high in

a few Asian economies



20

Corruption in Asian Economies

(Source: Transparency International: mean CorruptionPerception Index 1992-2000)

0

12

3

4

5

6

7

8

9

Economy

China

Taiwan

Hong Kong

Indonesia

JapanKorea (South)

Malaysia

Philippines

SingaporeThailand

United State

United Kingdom

How much side payment is needed for



21

How much side payment is needed forfirms to get 1 million bank loan in

China?

Appl i cat i on f ee f or 1 mi l l i on cor por at e l oan

010000200003000040000500006000070000

C o u n t r y

A v e r a g e

N o r t h

C h i n

a

N o r t h - E a

s t C h i

n a

M i d d l e

C h i

n a

E a s t

C h i

n a

S o u t h

C h i n

a

W e s t

C h i

n a



22

Cost of maintaining relationshipwith banks in China

The cost needed t o mai nt ai n t he l oan

r el at i onshi p wi t h bank r epr esent ed by i nt er estr at e

0. 00%

1. 00%2. 00%3. 00%4. 00%5. 00%6. 00%

7. 00%

C o u n t r y

A v e r a g e

N o r t h C h i n a

N o r t h - E a s t

C h i n a

M

i d d l e C h i n a

E a s t

C h i n a

S o u t h C h i n a

W e s t

C h i n a



A case in point –China Construction Bank

Wang Xuebing Zhang Enzhao

A i i Chi



24

A case in point – China

Construction Bank China’s third-biggest lender

On the verge of initial public offering in HongKong., chairman Zhang Enzhao resigned onMarch 16, 2005, for “personal” reasons

It was revealed that Zhang was involved in a

corruption scandal in which he took bribe of $1million in the U.S. He is being investigated bythe communist party

Wang Xuebing , the former chairman of the bankwas also removed due to corruption a few yearsback

Directors and other senior managers of the bankwere uninformed about Zhang’s problem untilrumor spread around March 14

What went wrong?

C t G f



25

Corporate Governance of

Banks in China All government owned Government appoints senior management

(not just chairman and CEO) Few senior management appointed

externally from markets Executive compensation is inflexible Communist party committee dominates

the board of directors Party committee members serve as key

members of other boards (director,supervisory, management)

O hi St t f



26

Ownership Structure of

China Construction Bank


Central Exchange and Finance Corp.(73%)

Bao Steel(10%)

National Electricity Net(10%)

Yanzi River Electric Power(7%)

G St t f



27

Governance Structure of


China Construction BankChina Construction Bank

CommunistParty Committee

*11 people,Zhang was the party secretary

CommunistParty Committee

*11 people,Zhang was the party secretary

Board of Directors*Zhang was the chairman,

3 out of 13 directors fromthe Party Committee

Board of Directors*Zhang was the chairman,

3 out of 13 directors fromthe Party Committee

Supervisory Board*4 members,

chairman from theParty Committee

Supervisory Board*4 members,

chairman from theParty Committee

Management

*7 people, all from the Party Committee

Management*7 people

, all from the Party Committee



28

Entrenchment Problem at the


Both corrupted chairmen were long-timer of the

bank and were approaching retirement age The chairman’s decisions were uncontestable by

other directors and managers.

The chairman is also the party secretary whocontrols the party committee.

Once a decision is passed in the party committee,it won’t be challenged by other boards as these

other boards are controlled by the party boardmembers

What are needed for improving the



29

What are needed for improving thegovernance of government banks?

Making bank ownership transferable.This is usually done throughprivatization

Firewall that prevents politiciansfrom intervening banking decisions

based on self-interests Mechanisms that prevent

managerial entrenchment



30

Effects of weak bank governance:

High Corporate Financial Leverage

Companies in Asia rely on debt much more

than equity to finance their investment Moreover, they rely on short-term debt,

even when they engage in long-term

investment Banks, not capital markets, are the primary

sources of funds for firms in Asia and other

developing countries Why are these?



31

Cross country pattern of corporateleverage (Fan, Titman, Twite, 2004)

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

K o r e a , R e p .

T h a i l a n d

I n d o n e s i a

I n d i a

B r a z i l

P h i l i p p i n e s

C h i n a

A u s t r i a

P a k i s t a n

I t a l y

P o r t u g a l

J a p a n

F i n l a n d

D e n m a r k

S w i t z e r l a n d

B e l g i u m

F r a n c e

H o

n g K o n g , C h i n a

C a n a d a

M e x i c o

I r e l a n d

P e r u

T a i w a n

N e w

Z e a l a n d

S p a i n

C h i l e

S i n g a p o r e

M a l a y s i a

N e t h e r l a n d s

G e r m a n y

S w e d e n

N o r w a y

U n i t e d S t a t e s

A u s t r a l i a

U

n i t e d K i n g d o m

I s r a e l

T u r k e y

S o u t h A f r i c a

G r e e c e



32

Cross country pattern of corporatedebt maturity (Fan, Titman, Twite,2004)

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

C a n a d a

S w e d e n

N e w Z e a l a n d

U n i t e d S t a t e s

A u s t r a l i a

N o r w a y

F i n l a n d

I r e l a n d

S w i t z e r l a n d

M e x i c o

D e n m a r k

I n d i a

N e t h e r l a n d s

S o u t h A f r i c a

C h i l e

P o r t u g a l

B r a z i l

F r a n c e

B e l g i u m

U n i t e d K i n g d o m

G e r m a n y

P h i l i p p i n e s

I s r a e l

J a p a n

S p a i n

A u s t r i a

K o r e a , R e p .

H o n g K o n g , C h i n a

I t a l y

P a k i s t a n

P e r u

T a i w a n

T u r k e y

I n d o n e s i a

M a l a y s i a

T h a i l a n d

S i n g a p o r e

C h i n a

G r e e c e

Rent seeking and Corporate



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Rent seeking and Corporate

Finance In a country plagued by weak public

governance, the government is a weakenforcer (or even a violator) of propertyrights, and debt (bank loans) providebetter protection than equity

Politicians/bureaucrats channel funds to

their favored firms through banks theycontrol

See below research evidence from China



34

High-level Government Officers

Corruption Cases in China, 1995-2004

Rent Seeking and Firm Leverage



35

in China

(Fan, Rui, Zhau)Mean Leverage - Total Debt/Assets

(Briber+Related and Unrelated Firms)

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

-3 -2 -1 0 1 2 3

Years around Event

Briber+Related Firms

Unrelated Firms

Rent Seeking and Long-term DebtFi i i Chi



36

Financing in China

(Fan, Rui, Zhau)Mean Long Term Debt/Assets


0

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.1

-3 -2 -1 0 1 2 3

Year around Event


Unrelated Firms

R t S ki d C t D bt



37

Rent Seeking and Corporate Debt

Maturity in China (Fan, Rui, Zhau)Mean Maturity - Long Term Debt/Total Debt


0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

-3 -2 -1 0 1 2 3

Year around Event


Unrelated Firms



38

Conclusions Corporate governance of banks in Asia is

fundamentally shaped by the banks’ businessstrategy, ownership, and more fundamentallypublic governance and government regulations

There is no strong evidence that deviation of western governance practices hurt bankperformance

Governance reforms merely at the bank levelalone are unlikely to be effective

Deeper reforms at the country level, such as

fighting corruption, will result in changes in bankgovernance

Corporate Governance of Banks in Asia - Joseph Fan

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