March 2011 PERSPECTIVES CORPORATE GOVERNANCE AND ACCESS TO FINANCE

Transcription

1 62 March 2011 PERSPECTIVES CORPORATE GOVERNANCE AND ACCESS TO FINANCE

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3 CORPORATE GOVERNANCE AND ACCESS TO FINANCE This study has been prepared by a team of Analistas Financieros Internacionales (Afi) co-ordinated by Santiago Fernández de Lis and integrated by Rafel Crespí (UIB), Verónica López Sabater, María Encina Osorio, Paula Papp, Esther Rodríguez and Francisco José Valero. We are grateful for the comments received from Anne-Françoise Lefèvre from WSBI. This study was finalized in December 2010.

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5 TABLE OF CONTENTS Foreword 7 Executive Summary 9 1. Introduction The link between Corporate Governance and Access to Finance Corporate Governance Conceptual Framework Access to Finance Conceptual Framework Empirical evidence 75 Annex 1: Review of the literature 95 Annex 2: Case Studies 113 Case Study 1: Sparkassen Finanzgruppe 113 Case Study 2: Kenya Post Office Savings Bank (KPOSB) 122 Case Study 3: Philippines Postal Savings Bank (PPSB) 130 Case Study 4: Spanish Savings Banks 137 Case Study 5: Cajas Municipales de Ahorro y Crédito (CMAC) 144 in Peru Annex 3: Questionnaire 155 Annex 4: The Honohan Index 157 Annex 5: Quantitative Results 161 References 165 5

6 Boxes Box 1. German Sparkassen 27 Box 2. Kenya Post Office Savings Bank (KPOSB) 36 Box 3. Philippines Postal Savings Bank (PPSB) 53 Box 4. Spanish Savings Banks (CECA) 55 Box 5. Cajas Municipales de Ahorro y Crédito (CMACs) in Peru 64 6

7 FOREWORD I am pleased to present the findings of the Corporate Governance and Access to Finance study, released by the World Savings Banks Institute in collaboration with the consultancy AFI (Analistas Financieros Internacionales). Can adequate corporate governance increase access to financial services? While the answer is not straightforward, the following study reveals that countries with better standards of corporate governance tend to have higher levels of financial inclusion and deeper banking market penetration. Moreover, corporate governance elements controlled by the institution have far greater positive influence on financial access efforts than do external corporate governance elements, such as national legal frameworks. Interestingly, a clear reference to access to finance in the institution s mission statement is one of the internal elements that have the greatest positive influence, as it helps institutions adhere to their inclusive finance policies. In the debate over how to increase financial services access to the maximum number of people, corporate governance is much more relevant than, say, the questions of institution ownership. WSBI is encouraged by these findings, for who is better positioned than savings banks to put high standards of corporate governance to work for the benefit of those in need of financial access? Chris De Noose WSBI-ESBG Managing Director 7

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9 EXECUTIVE SUMMARY Background and objectives of the study n n n Access to Finance is an important objective for WSBI members, in the context of their double bottom line banking approach, according to which they seek (i) to bring a return to the communities where they operate, including by offering financial services to underserved segments of the population and at the same time (ii) to make a reasonable profit that ensures the sustainability of the institution. WSBI members foster Access to Finance from a multi-faceted perspective: in a geographical dimension, by providing financial products to underserved population in rural and remote areas; in a product dimension, by offering accessible and affordable services, adapted to the specific needs of low income population; and in a time dimension, by maintaining a more permanent relationship with clients and following more stable policies in the good and bad times, thus being less pro-cyclical than the average banking institution. The first two features contribute to the objective of financial inclusion, and the third one both to financial inclusion and financial stability. At the same time, WSBI members follow Corporate Governance standards set by international bodies or institutions or by national regulators, which is a condition for WSBI membership. According to a survey developed for this study, 87% of members have an internal Corporate Governance code. 9

10 n n It seems natural to assume that Corporate Governance practices of WSBI members are linked to their Access to Finance objective. The interactions between these two aspects, however, have never been explored, despite the fact that the role of WSBI members in Access to Finance and their compliance with Corporate Governance practices are well established. This study therefore looks at the potential impact of the Corporate Governance model of member banks on their customer outreach, trying to address questions like the following: To what extent is Access to Finance influenced by Corporate Governance practices or other factors? Are there specific Corporate Governance practices supporting the compliance with the Access to Finance mandate? Which Corporate Governance practices contribute the most to financial inclusion (or the fight against financial exclusion)? To address these issues a questionnaire was circulated to WSBI members, and five case studies were analyzed- Sparkassen Finanzgruppe in Germany, Kenya Post Office Savings Bank, FEPCMAC (Federación Peruana de Cajas Municipales de Ahorro y Crédito) in Peru, the Postal Savings Bank in the Philippines and the Cajas de Ahorros (savings banks) grouped in CECA (Confederación Española de Cajas de Ahorro) in Spain. A review of the literature was also conducted (see Annex 1). The link between Corporate Governance and Access to Finance n Corporate Governance can be defined in very broad terms as the mechanisms connecting (i) the interests of the company s owners and other stakeholders and (ii) the way its board of directors and management exercise their functions (see OECD, 2004). In the case of financial institutions, Corporate Governance presents a number of specificities as a result of their systemic relevance, their dependence on trust of the clients and the public at large and the fact that they are subject to strict regulation to limit risk assumption. All this implies that the interests of other stakeholders (different from shareholders), like depositors, taxpayers and employees, are particularly relevant for financial institutions, as illustrated by the global financial crisis. Given their institutional configuration, WSBI members are particularly sensitive to a wider group of stakeholders, compared to commercial banks. 10

11 n n Access to Finance in enshrined in WSBI members business models and practices, which is reflected in the provision of accessible financial services through a large distribution network. The model of proximity banking, the design of special and innovative products for the underserved population and the attention to the objective of financial education are common traits of member institutions. Measuring Access to Finance is however challenging, both at the country level and at the institution level. WSBI members, despite the diversity in their ownership and institutional structure, present a number of common elements in their Corporate Governance. This is explained by two factors: (i) their compliance with common international standards, such as those of the Basel Committee on Banking Supervision, and (ii) their sharing of the Access to Finance objective. Statistical evidence n To estimate the statistical connection between Corporate Governance and Access to Finance, two dimensions have been considered for both variables: the country dimension and the institution dimension. For Corporate Governance, the country dimension has a strong influence on the institution dimension. Therefore, an overall Corporate Governance index was calculated taking into account both the country Corporate Governance environment and the institution Corporate Governance framework (this is consistent with the literature, according to which the legal and institutional environment affects the Corporate Governance quality of a given institution). For Access to Finance the three most common indicators were used: average deposit, average credit and deposits per 1,000 adults. Regressions for the Corporate Governance indices (as well as their subcomponents) and the Access to Finance indicators were calculated. The results suggest that a link exists between Corporate Governance and Access to Finance, although their statistical reliability could be improved through a larger number of available observations. 11

12 n n Establishing a direct and causal relationship between Corporate Governance and Access to Finance is not straightforward, even though a correlation between both seems to exist. A number of other factors explaining savings banks outreach also need to be taken into account. The degree of financial development of the market in which savings banks operate, the financial system infrastructure or the macro - economic environment are part of those key elements. Others, such as the degree of competition in the financial sector, the types of intermediaries, and the range of products and services they offer (as well as their main features and cost) do also condition the success of savings banks Access to Finance efforts. The statistical analysis suggests a positive correlation between Corporate Governance and Access to Finance both at the country level (chart A) and at the individual institutions level (chart B). Chart A: combining indicators from previous studies 1 with our own database, Corporate Governance seems to be correlated with Access to Finance at the country level. Furthermore, when the country has a good Corporate Governance framework and WSBI members have a higher market share in the country (shown by the size of the dots), financial outreach tends also to be higher. Chart B: Access to Finance indicators for individual WSBI members were also calculated, based on references traditionally used in the literature: average deposit size, average loan size and deposits per 1,000 adults. When comparing these indicators with a Corporate Governance index defined for the purpose of this study, we found that, in the case of developing countries, there is a correlation between the quality of Corporate Governance and the three Access to Finance indicators, stronger and more reliable in the case of the average deposit size. 1 See section 5 for references. 12

13 Chart A. Corporate Governance, Access to Finance and market share of WSBI members (country level) Source: Own elaboration. Afi, Analistas Financieros Internacionales. See Chapter 5 for definitions, data sources and data treatment. The Honohan Index measures the fraction of adult population using formal financial inter - mediaries. It varies between 0 and 1. The Country Corporate Governance level is measured through a combination of indicators including the strength of legal rights, the depth of credit information and the level of financial development. The size of the dots reflects the market share of WSBI members in their respective banking system. The tendency line helps to visualise the correlation between both variables. This chart suggests that in countries with a better Corporate Governance environment and a relatively higher presence of institutions with an Access to Finance mission (like WSBI members) financial outreach tends to be higher. 13

14 Chart B. Corporate Governance and Access to Finance measured as average deposit size (individual institutions level) Source: Own elaboration. Afi, Analistas Financieros Internacionales. The average deposit is divided by GDP per capita (the lower this indicator the higher Access to Finance). The Overall Corporate Governance index combines the country index and an institution specific component, which takes account of the Board composition, including gender equality, the existence of an external audit, rating from an agency of internal Corporate Governance code and the clarity of the mission inter alia. See section 5 for the precise definition. The tendency line helps to visualise the correlation between the Overall Corporate Governance index and Access to Finance measured as the size of the average deposit. This chart evidences that in the case of developing countries, as the quality of Corporate Governance improves, financial outreach also improves: the average deposit decreases, which indicates a deeper banking market penetration. 14

15 n The study also shows that Corporate Governance components which are under the control of the institutions have more influence on promoting better accessibility to financial services than the country components, connected to the national legal framework or the business environment. In this respect, the internal elements of Corporate Governance that contribute most to a higher Access to Finance are (i) the inclusion of a clear reference to Access to Finance in the mission statement of the institution; (ii) the separation between CEO and Chairperson; (iii) the existence of an external audit, an internal Corporate Governance Code and/or a rating from an external agency, and (iv) the proportion of women in the Board. Corporate Governance practices to improve Access to Finance n n n The members of the WSBI are diverse, including public banks, cooperatives, mutuals, postal savings institutions, private institutions etc. Each of these types of institutions has certain specificities from the point of view of Corporate Governance, given their specific organizational and ownership structure (see section 3). Despite these differences, they share a number of common Corporate Governance characteristics. This similarity is partly the result of the fact that most WSBI members comply with standard Codes of Corporate Governance, although the latter are in general designed for shareholder-driven institutions. Overall compliance with such codes and standards, in accordance with Basel Committee recommendations, is beneficial for any financial institution. It is however advisable to tailor these codes to the specific characteristics and mission of WSBI members, which share a double bottom line objective. It is desirable that Corporate Governance mechanisms in these institutions reflect a balance between the two objectives of Access to Finance and sustainability. For institutions having a strong financial inclusion aim, it is important to include an explicit reference to this objective in the mechanisms that ensure accountability of the governing bodies. Clarity of the Access to Finance mission is indeed essential to ensure that business strategic policies and operations are directed towards this goal. 15

16 n n Mechanisms to ensure management accountability vis-à-vis these objectives, especially in the case of public banks, are also needed. The definition of the mission of CMAC Arequipa in Peru is a good example of clarity: to benefit segments of the population lacking financial support of traditional banking. Postbank of Kenya provides another good example of sound accountability practices, through a performance contract that sets quantitative and precise objectives of Access to Finance (like a certain increase in the deposit base, in the number of customers accounts or in the establishment of point of sales). Management performance is evaluated against these objectives. Financial regulation and supervision tend in general to favor Corporate Governance practices that consider the interest of all stakeholders (in particular depositors), beyond the narrow interest in maximizing short-term shareholders value. This need to take into account the interest of a broad group of stakeholders in the management of banking institutions has been enhanced by the global financial crisis. One of the distinguishing features of WSBI members is precisely that they are oriented towards the interest of a wider group of stakeholders. Representation of these stakeholders in the governing bodies of the institution should reflect this reality through an appropriate balance. The recent global financial crisis has highlighted also the damaging impact of the pro-cyclical behaviour of certain segments of the financial system, which exacerbates real economy fluctuations. The long term orientation of their business strategies implies that WSBI members tend to establish a more permanent relationship with their clients, lending more in relative terms in the bad times, making therefore a significant contribution to the stability of the financial system, and at the same time supporting the efforts towards greater Access to Finance. 16

17 1. INTRODUCTION 1.1. Focus and objectives of the study The World Savings Banks Institute (WSBI) members reiterated at their 22nd World Congress in May 2009 their firm determination to maintain their commitment in favour of the promotion of financial inclusion (Santiago Declaration) 2. At the same time, they renew[ed] their call for the opportunity to review the Corporate Governance framework applicable to banking institutions, a need that has become pressing in the context of the current global financial crisis, which has highlighted the strengths of the WSBI members business model. The link between a good Corporate Governance and appropriate Access to Finance has always been implicit in WSBI members mandate and mission, but the recent focus on banking sector governance practices (and the debate on possible reforms in the aftermath of the crisis) has heightened the relevance of this connection. To the extent that financial inclusion is one of the key objectives of WSBI members, their Corporate Governance practices should be designed in a way conducive to achieving this objective, inter alia. The present study aims at investigating the connection between Corporate Governance and Access to Finance in WSBI members from an eminently practical point of view, trying to address questions like the following: to what extent are WSBI members Corporate Governance practices suitable to foster Access to Finance in their country or region? Which Corporate Governance practices can be identified as particularly useful to deepen financial inclusion (in emerging and developing countries) or fighting financial exclusion (in industrial countries)?

18 Are there some general good practices in Corporate Governance that can be identified as facilitating Access to Finance? To what extent are there differences among the diverse types of WBSI members worth mentioning in this regard? The public (households, small enterprises) need financial services both as vehicles of savings and credit. Financial inclusion concerns therefore both sides of the banking sector balance sheet. WSBI members diversity implies that while all institutions offer savings products, only 76 percent of them offer credit products, generally those that are not postal banks. The Corporate Governance requirements of these deposit-taking only institutions could be different. For example, regulation, supervision and risk controls are essential components of Corporate Governance in the case of institutions that transform saving into credit, but less so in the case of non-lending institutions. WSBI members are, indeed, diverse: they include only-saving and saving and lending institutions; public and private institutions, mutuals and foundations etc. All these distinctions may entail certain specificities from the Corporate Governance viewpoint. But common elements can also be identified that lead all these institutions to organise themselves along certain principles that ensure that they fulfil their common mission of facilitating Access to Finance Corporate Governance and WSBI member banks The debate on Corporate Governance received increasing interest over recent years. It focused initially on non-financial, shareholder companies, but expanded rapidly to the financial industry and to other types of ownership structures. A number of specificities of financial institutions need to be taken into account when dealing with Corporate Governance, as has been made clear by the global financial crisis: their systemic nature, their vulnerability to sudden losses of confidence, their ultimate dependency on public funds (taxpayer money) in a crisis situation and, partly as a result of all the above, the need for a strict regulation and risk control policies. All this calls for a specific regulation of Corporate Governance in the case of banking institutions, which requires accountability to a wider array of stakeholders than the typical, non-financial firm. 18

19 WSBI members are by definition accountable to more stakeholders than the average financial institution. In the case of savings banks, the interests of depositors, employees and the local or regional communities are typically taken into account. Representatives of all these groups are in many cases included in the governing bodies of these institutions, through Corporate Governance practices that are particularly suitable for financial inclusion. Public institutions like postal banks for example, are established to provide financial services to the community at large and are therefore accountable to the authorities and ultimately to taxpayers. All in all WSBI members, despite their diversity, fit particularly well in a model of banking connected to multiple stakeholders. Through their WSBI membership, and as part of the membership criteria, savings banks are invited to comply with sound and transparent Corporate Governance practices, in line with the generally agreed principles of good Corporate Governance such as the 2004 OECD Principles of Corporate Governance and the 2006 Basel Committee Guidance on Corporate Governance for Banking Institutions revised in October 2010 in the document Principles for enhancing corporate governance. In 2007, WSBI amended its statutory provisions to strengthen the Corporate Governance commitment of its members 3. These adjustments were introduced with a view to support the consensus which recognises that one of the most important criteria to assess the strength of an institution is not its business model nor its ownership structure, but its commitment to good governance practices (e.g. solid control environment, high levels of transparency and disclosure, an empowered board of directors etc) Access to Finance and WSBI member banks Access to Finance has traditionally been a key objective of WSBI members. This objective is particularly important in a crisis context. When credit shrinks, financial institutions strategies become especially prudent and there is a risk of financial institutions limiting access to clients in the less profitable regions or communities, closing branches whose short-term profitability is below average or limiting credit to SMEs. This is particularly damaging in the case of emerging and developing countries that are in the middle of a process of financial deepening crucial to their development strategies

20 The definition of Access to Finance presents certain differences in WBSI members depending on the level of development of their countries. In emerging and developing countries, Access to Finance is closely connected to the notion of financial inclusion: the provision of access to appropriate, convenient, usable, valuable and affordable financial services and products to the widest part of the population, especially through the delivery of basic banking services to the low income people and the still unbanked, as a way out of poverty (WSBI Santiago Declaration). In industrial countries, where the majority of the population has access to financial services, the objective is to prevent and avoid financial exclusion, in particular in the case of the most vulnerable parts of the population (eg. unemployed, population in rural or remote areas, migrants, single parent households). While in the first case public policies should seek facilitating access to the middle and low levels of the pyramid, in the second case they are typically addressed at fighting segregation or discrimination against certain segments of the society that, for different reasons, face difficulties in having access to formal financial services. The objective of Access to Finance needs to be balanced with the need to ensure the long term sustainability of the institution, in what the WSBI defines as the double bottom line banking model, according to which savings banks have a clear dual mandate to (a) bring a return to the communities in which they operate, including to reach the unserved and underserved groups and (b) try and make a reasonable profit so that the outreach achieved can be self-sustainable. There is no trade-off between financial inclusion and profitability and the two objectives pursued by WSBI members are mutually supportive. WSBI members have traditionally worked towards fostering financial access as one of their main objectives. Consistent with this view, financial access occupies a prominent role in their mission statements and/or vision designs. Most of them have also adopted specific tools to achieve these targets and set performance indicators that measure their results in terms of Access to Finance. WSBI members globally make a substantial contribution in deepening financial inclusion (or combating financial exclusion) in their respective regions or countries. 20

21 For the particular case of developing and emerging economies, WSBI members have consistently made efforts in this sense, as shown by the fact that of the estimated 1.4 billion accessible accounts existing at institutions across developing economies with an explicit mission to foster access, some 1.1 billion are provided by savings banks Presentation of the study This study will address the link between Corporate Governance and Access to Finance in WSBI members by means of (i) statistical evidence from previous studies, (ii) specific statistical data collected from WSBI members through an ad-hoc questionnaire and (iii) five case studies, the selection of which was based on a sample to cover the diversity of WSBI members, in terms of types of institutions, regional representation and national income level. These five cases are Sparkassen Finanzgruppe in Germany, Kenya Post Office Savings Bank/Postbank in Kenya, FEPCMAC (Federación Peruana de Cajas Municipales de Ahorro y Crédito) in Peru, the Postal Savings Bank in the Philippines and the Cajas de Ahorros (savings banks) grouped in CECA (Confederación Española de Cajas de Ahorros) in Spain. Afi visited all these members during the research period, including visits to individual savings banks when the member is an association (Germany, Spain and Peru). The case studies will be used along the text to illustrate some of the main ideas, practices and results. Table 1 highlights some of the key features of the selected institutions. This paper is distributed in six sections. The second section motivates the report and explains the relationship between Corporate Governance and Access to Finance, using some examples from the case studies to illustrate this link. The third section analyses the conceptual framework of Corporate Governance, its definition, features and implementation in different organizational forms. The fourth section discusses Access to Finance issues, emphasizing its different dimensions and the difficulties for its measurement. The fifth section analyses the data collected and provides some empirical evidence based on descriptive statistics for the relationship between Corporate Governance and Access to Finance. 4 See Perspectives 52, September 2006 Savings banks and the double bottom line A profitable and accessible model of finance, (ESBG_only)/Perspectives%2052.pdf. 21

22 Table 1. General characteristics of the five selected Case Studies Germany Kenya Peru Philippines Spain Type of Institutions Saving Banks Postal Bank Saving Banks Postal Bank Saving Banks Owner Municipalities Government Municipality Post Corporation Created by are the Traeger of Kenya a private foundation (responsible (no owner) institution) (except 6) Supervision by Yes No, Ministry Yes Yes Yes Central Bank of Finance Number of institutions Market share 31,6 %** 3% 4% 0.1% 50% (% total deposits)* Provision of Credit Yes No Yes Yes Yes World Bank country OECD Low income Upper middle Low upper middle OECD classification (income) country (LIC) income country income country (MIC) (LUC) * Source: based on Access to Finance questionnaire distributed by WSBI to all members. For the Philippines case, market share is measured as percentage of total assets. ** Savings banks only; the figure is 41.1% if other members of the network are included. 22

23 2. THE LINK BETWEEN CORPORATE GOVERNANCE AND ACCESS TO FINANCE The initial objective of Corporate Governance principles is to align the incentives of managers and shareholders in order to overcome the principal agent problem. This approach, however, assumes that shareholders interest is to maximize profits. In the case of financial institutions, Corporate Governance should take account of the interest of other stakeholders (depositors, savers, life insurance policy holders, etc) 5, and the objectives of the institution need to be defined more precisely, given the broader impact of its activities on economic development, financial stability and social cohesion. This is particularly relevant for institutions having a financial inclusion objective, like WSBI member banks. This section provides an overview of the main potential interactions and mutual influences between Access to Finance and Corporate Governance, as applied in financial institutions such as savings banks. A series of possible links are examined and good practices are identified, with particular regard to: (i) the importance of the mission of the institution, and the impact on its proximity banking vocation as well as its translation into products designed to foster financial outreach; (ii) the anticyclical behaviour of proximity banking through the long term commitment with its clients; (iii) the broader contribution to the welfare of the community through the use of profits for community projects; (iv) the mechanisms to ensure accountability to stakeholders; and (v) the role of financial regulation and supervision. 5 See EU Commission (2010). 23

24 This list of topics is intended to provide a general view of the main mechanisms that connect Corporate Governance and Access to Finance. In doing so, the experience of the five case studies and also other WSBI members is used as an example when relevant Access to Finance mission For most WSBI members, their objectives are well summarized in the double bottom line : playing a role in the social and economic development of the local community, including through the provision of Access to Finance to unbanked/vulnerable segments of the population, and ensuring the long term sustainability of the institution through an adequate profitability. The link between Corporate Governance and Access to Finance should seek ensuring management accountability as regards the financial inclusion objective. A pre-requisite is the clarity in the definition of the mission of the institution. A necessary element of any strong institution that promotes Access to Finance is a clear and sustainable mandate, which should be revised periodically to ensure that the institution remains relevant and adapts to the changing market circumstances. Table 2 examines the mission statements of the five WSBI members under study. Some examples of this clarity in the mandate can be found in the Peruvian CMACs mission statement: to benefit segments of the population lacking financial support of traditional banking (CMAC Arequipa) or to provide financial services with efficiency, timeliness and competitiveness, both to small and micro enterprises (SMEs) and to families who normally do not have access to the banking system (CMAC Piura). Another example is the Postal Bank of Kenya, whose mission includes to provide accessible and sustainable banking and other related financial services. The explicit reference to Access to Finance in the mission statement will serve as a basis to support financial inclusion efforts of the savings banks, mainly through the development of proximity banking activities thanks to an extended distribution network, and the offer of financial services and products tailored to the specific needs of underserved or unbanked people. 24

25 Table 2. Main features of the Mission in the five selected Case Studies Statement Access to Finance Sustainability Germany Kenya Peru Philippines Spain Public mission: assuring to provide in their respective region financial services tailored to the needs of the population, the small and medium sized companies and the public sector without discriminating against any customer group and thus to promote the development of their respective regions. Provide accessible and sustainable banking and other related financial services, through innovative delivery systems for wealth creation to the benefit of customers and other stake - holders and by encouraging thrift through mobilization. Each CMAC has articulated its own mission statement, all of them clearly related to fostering financial inclusion. Provide the Filipino people with a full range of professional banking and financial services accessible in all areas of the country and promote the values of thrift, industry and prudence especially in the youth. (i) The creation for social and economic wealth, (ii) The fight against social and economic exclusion and (iii) The generation of economic activity by returning earned profits to society. Defined in general terms Defined in general terms In general, explicit reference Defined in general terms In general, explicit reference Double objective: accessibility and profitability. Yes. In addition, Performance Contract of Board and Management includes financial indicators Yes: i.e. CMAC Sullana ("Profitable Microfinance institution ). - Clearer objectives on profitability than on Access to Finance. Source: Own elaboration. Afi, Analistas Financieros Internacionales. 25

26 The maintenance and the development of a wide distribution network, including in remote and unserved areas For most WSBI members, proximity banking is a vocation in so far as their origin and institutional configuration create a natural tendency towards providing financial services to the community in which they operate. Spanish Cajas and Peruvian CMACs, although authorised at a certain stage to expand to other regions, tend to maintain strong local roots in their region of origin. This approach, together with the fact that they do not aim at profits as the only objective, implies that WSBI members often operate in locations which are not served by other financial institutions. For example, Spanish Cajas are the only financial provider in 14 percent of the municipalities of the country, and represent 70 percent of the total number of financial outlets in municipalities with population below 1,000 inhabitants. The commercial network of Caixanova provides essential proximity banking services to rural and dispersed communities in the region of Galicia 6. In the case of Germany, figure 1 illustrates that the population per branch is much lower for Sparkassen than for other banks. This proves the commitment of Sparkassen to be close to their clients, devoting more time to personal contact with them, lowering access barriers for those vulnerable to financial exclusion (among others the young and elderly). Box 1 highlights the vocation of German Sparkassen to provide financial services to underserved communities and how this proximity benefits the communities where they operate. 6 See Perspectives 57 Measuring the social dividend in WSBI members activities: Revealing the hidden elements, New_publications/DOC_ESBG_PERSPECTIVE_57.pdf. 26

27 Figure 1. Germany: population per branch in rural districts and towns not belonging to the rural district. Source: German Central Bank and DSGV BOX 1. GERMAN SPARKASSEN Corporate Governance Sparkassen are governed by the Savings Banks Laws of the respective Länder. Despite differences in some detail of legal definitions, Sparkassen have a very clear mandate: to supply financial services to the population and to promote the development of their respective regions, by granting loans to SMEs, while preserving their long term viability. Though each Sparkasse is an independent institution, they form part of a network system (Verbund) where they share certain functions and services. It is this network system that is an essential basis for keeping independence and decisionmaking power on the local/regional level and thus as close to private customers and SMEs as possible. An important feature of the network system is the support of one another by means of the Joint Liability Scheme. German savings banks are (with a few exceptions) public-law institutions that can only be set up by local authorities (kommunale Körperschaften), like municipalities and districts, who act as the Träger (or responsible body) for the savings bank. As a natural consequence the major focus of the business activities of the Sparkasse has to lie in the geographic area of their Träger, what is called the regional principle. 27

28 Access to finance Sparkassen promote access to finance from both a regional and a temporal dimension. The German Savings Banks provide financial services to clients in all parts of the country, in dynamic centres as well as in the less developed regions. In most rural areas Sparkassen and cooperative banks are the only relevant financial institutions. From a temporal perspective, Sparkassen due to their very broad and diversified customer base and their strong roots in a specific region tend to function to a certain extent in an anti-cyclical manner: they are less prone to overheated credit expansion in the good times and to credit crunches in the bad times, thus contributing to financial stability. In addition, Sparkassen play a complementary role with respect to privately owned commercial banks, servicing underserved clients. The German Savings Banks have a customer advocacy proposition, which implies that they are obliged to open an account to any citizen or company fulfilling certain criteria. Sparkassen very often are the only option to access basic financial services for clients whose profitability is below a certain threshold. There are many specific examples of this complementary role of Sparkassen, e.g. the establishment of specific branches for young people, the development of special financial products for the aged, and the provision of microcredits that benefit mostly long-term unemployed people and are accompanied by a financial education program, making it a critical instrument in combating financial exclusion. The link between Corporate Governance and Access to Finance Because their clear double mandate forces them (i) to be financially viable (but does not require a short-term profit similar to mainly shareholder-value driven financial institutions) and (ii) serve a public aim, Sparkassen keep branches, ATMs and accounts that would otherwise be closed if only short-term profit maximisation objectives were considered. A strong orientation on long-term profitability allows sustainable banking even in problematic geographic areas. 28

29 A recent WSBI publication 7, shows that geographic proximity plays a crucial role in lending to SMEs in Germany and is particularly relevant for companies that are facing cash flow problems. The regional principle also reinforces the fight against financial exclusion. Sparkassen s business activities are concentrated on their regions, which prevents them from abandoning regions that may not be as profitable and expand into growth regions The offer of tailored financial services and products to suit the needs of unserved and underserved categories of clients A particularly clear reflection of the role of WSBI members in financial access policies is the provision of products especially designed to suit the specific needs of unbanked or underbanked parts of the population. Most members of WSBI offer such products, adapted to the requirements of their environment. In Peru CMACs are concentrated in the micro - finance sector, providing 29 percent of the total volume of the microcredits in the country. In Spain, Caixanova has designed a new microcredit product where the residual credit risk is supported by the Obra Social (the dedicated Fund for community-oriented projects), and la Caixa has a special product that allows migrants who open a savings account to send remittances at no cost. In Germany, many savings banks especially in vulnerable regions provide micro-loans (below ) whose recipients are mostly long-term unemployed, who receive also financial education in the context of the program. A frequent approach is to concentrate on certain segments that are not served by the regular financial system and where the institution has a comparative advantage or a special vocation. For example, in the Philippines, PPSB provides special lines of credit for the transport sector, in particular for the purchase of Jeepneys, a very popular vehicle for public transportation in Philippine cities, using a special government fund of 0.5 billion pesos (11 million USD) earmarked for the transport sector. 7 Balance Structural Policy: German Savings Banks from a Regional Economic Perspective, Perspectives 58, June

30 All these examples illustrate how proximity banking enhances financial inclusion through the offering of products tailored to the needs of clients that are not covered by conventional banking products. To a great extent this is possible because of the permanent contact with these clients and the constant identification of their wishes and aspirations Permanent commitment to the client: an anticyclical behaviour Institutions with a financial access mission and a vocation to serve the local community are more stable in their commercial practices (in particular lending) not only in a space dimension (facilitating credit in particular to rural areas) but also in a time dimension. This implies that, while commercial banks are more aggressive in the reaction to the perception of risk (increasing their propensity to lend in the good times and contracting sharply in the bad times), WSBI members are more stable and tend to smooth this pro-cyclicality inherent to the financial sector. Indeed, these institutions lending policies are oriented to servicing the client with a long term considerations rather than focusing on very short term profits. The recent global financial crisis has highlighted the damaging impact of the pro-cyclical behaviour of certain segments of the financial system, which exacerbates cyclical fluctuations of the real economy. The international community is discussing a profound reform of international financial regulation to reduce this source of instability, through mechanisms like dynamic provisions or anti-cyclical capital requirements. Through their longer term strategy and their commitment to foster financial access regardless of cyclical moods, savings banks and proximity banks make a significant contribution to financial stability. As can be seen in Chart 1, in 2008 and 2009 credit growth in a sample of WSBI members, representing 77% of the total WSBI network s assets, exceeded by 4 points the average of their respective countries. The rate of credit growth of each of the WSBI members exceeded the banking system average in two thirds of the countries included in the sample. 30

31 Chart 1. Credit growth: average for WSBI members vs. country average in 2008 and Issues of Sukuk (in $ billion) WSBI TOTAL Source: WSBI and own estimates based on data from national central banks. Simple average of 15 countries, representing 77% of WSBI members' assets. The long term orientation of their business strategies implies that WSBI members make a significant contribution to the stability of the financial system, lending more in relative terms in the bad times. In view of the huge costs for the taxpayers which result from the pro-cyclicality of some financial institutions, this contribution should be placed prominently among the benefits of the proximity banking model. This is the result of WSBI members compliance with their mission and institutional objectives, which are fundamental elements of their Corporate Governance mechanisms Profits used for welfare-improving projects Most WSBI members devote considerable resources to community investment projects and activities. In 2009, Sparkassen allocated more than half a billion euro to finance projects in the areas of culture, social activities, sports, science, education, environment protection and other community services. Spanish savings banks after tax profits, and after covering recapitalisation needs, are dedicated to the Obra Social, which finances projects for the social and cultural development of the community: sports centres, libraries, schools and infrastructure projects are a few examples. 28 percent of the overall profits of cajas have been devoted to these projects in

32 In the case of Peru, the profits that are distributed to the municipalities should be spent on infrastructure projects, although there are in general no specific mechanisms to ensure the enforcement of this rule. The use of the profits of savings banks in projects improving the welfare of the community is a means of reinforcing the roots of the institution and enhancing the visibility of its social function. After ensuring the longterm sustainability of the institution, it is natural that these profits (that are a result of the use of the community s resources) revert to the community. After this crisis, the perception of an excessive reliance of financial institutions on taxpayer s support strengthens the case for a social use of banks profits. Chart 2. Virtuous circle between Access to Finance and socio - economic development: the double-sided contribution of WSBI members Source: Own elaboration. Afi, Analistas Financieros Internacionales. Furthermore, contributing to the development of the community is another way to fuel the virtuous cycle between financial inclusion and financial development. On top of their contribution to financial inclusion, through their day-to-day business, WSBI members promote directly economic development, which in turn stimulates financial inclusion, thus accelerating the mutual feedback between both objectives. 32

33 2.4. Accountability to stakeholders A challenge of Corporate Governance of financial institutions, as mentioned above, is to make them accountable not only to shareholders, but also to depositors, taxpayers, supervisors and other stakeholders. WSBI members, having their roots firmly based in their community, are in general accountable to different stakeholders. This is reflected in the diversity of their governing bodies, which contributes to ensure a balance between the different interests of their stakeholders and between the different goals of the institution. The Peruvian CMACs provide a very interesting example in this regard: despite having only one shareholder (the municipality), the seven members of the Board are appointed by six different constituencies: (i) the majority and (ii) the minority representatives in the municipality, (iii) the chamber of commerce, (iv) the association of small businesses, (v) COFIDE, a public bank and (vi) the catholic church. This composition is, furthermore, protected by law. In the case of Spanish Cajas, the general assembly composition varies depending on their statutes, but it typically includes appointees by depositors, municipalities, regional government, employees and the founding entity. In the case of German Sparkassen, the composition of the Board of administration depends very much on the savings banks Law of the respective Land, but it is quite common that the board includes representatives appointed by the major democratic body of the municipality or district (2/3) and the saving bank s staff (1/3). The proportion of women in the Board is often used as an indicator of diversity. In a sample of 23 WSBI members, the average of women representation in the Board is 24 percent, as compared to, for example, 7 percent in EU25 commercial banks, according to Mateos de Cabo, Gimeno, and Nieto (2009). This shows not only that the Board of savings banks is more diverse, but also that the interests of minorities are better represented in its composition and that the Board is closer to certain types of clients, according to the literature on microfinance institutions (see Annex 1), thus contributing to foster Access to Finance. Internal and external controls are essential ingredients of Corporate Governance. Most WSBI members comply with standard good Corporate Governance practices for financial institutions, as defined for instance by the Basel Committee 8. 8 See BCBS (2010b) and Table 6. 33

34 Among the WSBI institutions that replied the questionnaire on Corporate Governance sent by the research team, all but one had been audited (either internal or external audit) in the last year and 87 percent have an internal Corporate Governance code, but only 38 percent are subject to an external credit rating (which is related to the small size of a significant numbers of member institutions, that do not have access to capital markets). Table 3. Corporate Governance in the five selected Case Studies: Quality of management, Control mechanisms and Corporate Governance Code Ensuring Qualified Management Specific knowledge and qualifications. Training provided by the academies of the national and regional associations if required. Members of the Executive Board have to fulfil the criteria defined by KWG (German banking act). Competence, agenda issues and gender. Checks and balances mechanisms Trustee committee looks at good governance and at management. Audited by the regional association and a Risk Monitoring System. Corporate Governance Code Yes Germany Kenya Performance Contracts. Target accomplishment (among them, Access to Finance) is evaluated by Government every quarter. If targets are not met and clarifications are not satisfactory the board is dismissed. Senior management evaluated with Scorecard. Risk of political interference from the only shareholder is mitigated by the diversity of the Board members and regulation and supervision by the banking supervisor (SBS). Yes and specific training program for first time appointed directors. Peru Meet moral and technical requirements. No 34

35 Ensuring Qualified Management Meet minimum qualifications. Corporate Governance Committee reviews the qualifications. Mandatory Director Education Program. Checks and balances mechanisms Board performs annual self assessment. Corporate Governance Committee ensures Board s effectiveness and compliance with Corporate Governance principles and evaluates director s performance. Board s Control Commission, reporting directly to the General Assembly. Two additional Commissions at the Board: investment and remunerations. Corporate Governance Code Yes, established by the SEC and Central Bank of Philippines. Philippines Spain Age (<65), qualifications, technical aptitudes and experience. Yes, mandatory for savings banks. Source: Own elaboration. Afi, Analistas Financieros Internacionales. Accountability mechanisms are a particularly important and especially difficult area of Corporate Governance. For institutions that have various objectives (at least two, according to the double bottom line approach), clarity in the definition of these goals is crucial to ensure accountability. The Postal Bank of Kenya provides a very interesting example in this regard: the performance contracts, according to which management is subject to specific quantitative objectives reflected in certain Access to Finance indicators, and remuneration is partly related to their accomplishment. These objectives are agreed with the government (owner) and their fulfilment is monitored on a regular basis. Targets for 2009 included several objectives related to Access to Finance: an increase in the deposit base by 30 percent, a 19 percent growth in the total number of customer s accounts, the introduction of 2 new products and the establishment of 50 new agents with their corresponding points of sale (POS). 35

36 BOX 2. KENYA POST OFFICE SAVINGS BANK (KPOSB) Corporate Governance The Government of Kenya has adopted as a policy, the application of Performance Contracts in the management and monitoring of the public service. In the case of KPOSB, the government and the Board signed a mutually agreed document that lists the key results areas, the levels expected towards the achievement of agreed targets, and how the performance will be measured. Board members and first and second level managers are evaluated according to this system. Other staff have been put on performance contract as well. This improves service delivery to the public by ensuring that senior managers are accountable for specific results. This monitoring is particularly important given that all board members are nominated by the government, which in the absence of a clear objective could lead to political interference, a major threat for a successfully functioning government-owned financial institution. Access to Finance KPOSB s mandate is to provide accessible and sustainable banking. Recent developments in the Kenyan financial sector have negatively affected KPOSB, which has lost market share. The three events that have severely impacted the Postbank are (i) the deterioration in the savings capacity of the low-middle income segment (KPOSB s target group) due to the post-election events in 2008 and the global financial crisis; (ii) the success of the Mobile banking operator M-PESA, a company which has provided Kenyans a cheaper and safer method to transfer money through cell phones; and (iii) the enactment of the Deposit taking Microfinance Act that allows MFIs not only to give credit but to collect deposits as well To keep providing accessible banking services, KPSOB has modernized itself, moving from savings book to cards. It has reached an agreement with M-PESA to become one of its banking agents and implemented a new business model to improve efficiency and customer service. In the new business model customers can use a debit card to transact at the Point of Sale Terminals. To supplement its network it has also reached agreements with Kenswitch and PesaPoint to add more than 650 ATMs to the network. KPOSB has installed 26 ATMs of their own. 36

37 KPOSB is also part of the Bill & Melinda Gates Foundation initiative to double the number of savings accounts among the poor. The KPOSB project s objective is to add 1.5 million customers (of which 1 million can be classified as poor) to the customer base by expanding a small existing pilot network of non-postal agents into a major new service channel in underserved rural areas. Corporate Governance and Access to Finance KPOSB s performance contract provides an excellent example of tools that promote sound Corporate Governance linked to financial inclusion. KPOSB s long term goals are included in a 3-year strategic plan and the short-term goals are specified in the annual Action Plan. The Performance Contract imposes quantitative and qualitative targets that emphasize the development impact of the bank policy on Access to Finance (for example, in 2009, these objectives include a 30 percent increase in the deposit base, a 19 percent increase in the number of deposit accounts, the introduction of two new market driven products and the expansion of the KPOSB network). This is complemented by targets in terms of bank s sustainability (like return on investment and debt-to-equity ratio). These specific targets are the basis for evaluating the Bank s compliance with the Action Plan on an annual basis. Progress reports are prepared on a quarterly and annual basis. Thus, performance contracts align the business strategy with the mandate of the company and make board directors and senior management accountable for fulfilling this mandate. When targets are not met, clarifications and corrective actions/measures are provided. If they are not satisfactory, the Managing Director s would be sanctioned including termination of contract. The Performance Contract system also offers bonus incentives for excellent performance The role of supervision and regulation Banking institutions depend on trust, and trust (as severely revealed in the recent crisis) depends on risk control and ultimately on the support by the government (the taxpayer). Mechanisms of public support like deposit insurance or the lender of last resort facilities require an adequate control of risks by financial institutions, hence the need for a detailed regulation, and the related banking supervision structure. 37

38 The fact that the banking system is a heavily regulated industry has important implications for Corporate Governance. Adequate control of risks is a necessity from both the regulatory and the Corporate Governance point of view. In many countries, banking regulators have encouraged the adoption of codes of Corporate Governance encompassing prudent risk management practices. And in many emerging and developing countries, the authorities (central banks, banking supervisors), aware of the essential contribution of financial deepening to the development of the country, have also stimulated policies to foster financial deepening. WSBI members are active part of both strategies: the tendency towards better Corporate Governance practices, through the adoption of international and domestic standards, and especially in emerging and developing countries the progress towards financial inclusion. Regulation is a driver of both policies. Although the link between Corporate Governance and financial inclusion (from the point of view of the regulator) could be weak in some countries, WSBI members, as catalysers of both lines of action, ensure their connection. All in all, financial regulation and more broadly public sector policies could establish an additional link between Corporate Governance and Access to Finance for WSBI members. An interesting example of this connection is the role played by COFIDE in the recapitalisation of Peruvian CMACs. As they rely only on retained profits for their re-capitalisation, CMACs face a challenge common to many other savings banks of insufficient instruments for a pro-active recapitalisation policy in case of need. COFIDE provides subordinated debt to CMACs on the condition that they retain as reserves a share of their profits above the legal minimum (at least 75 percent instead of the 50 percent legal minimum), thus providing a double mechanism to strengthen the capital base. This recapitalisation allows the Peruvian Cajas to pursue their financial inclusion policies that otherwise would be curtailed by insufficient resources. 38

39 Table 4. The link between Corporate Governance and Access to Finance Reference to Access to Finance in Mission Statement Compliance mechanisms Capitalisation processes Germany Yes Members of the Board and the regional principle ensure that proximity banking is taken into account along with profitability objectives. Only retaining reserves. If no capitalisation is needed, profits can be allocated to social activities in the region. Kenya Yes Specific targets in Management performance contracts ensure fulfilment of the mandate. Reserves retention and capital injections from Government. Peru Yes The presence of representatives of the local social, economic and political interests guarantees that CMAC activities benefit the local economy. Only retaining reserves. As joint stock corporations CMACs could in theory attract capital from external sources. Philippines Yes No Post office has only subscribed 50% of capital. Capitalisation via retained earnings insufficient. Spain Yes Access to Finance objectives not quantitatively stated. None of the Commissions explicitly evaluates their accomplishment. Only retaining reserves. Since 2007 issuance of cuotas participativas (non-voting shares) possible, but only used by one Caja so far 9. Source: Own elaboration. Afi, Analistas Financieros Internacionales. 9 The new law approved by the Spanish government in July 2010, when this report was in an advanced stage of finalisation, would facilitate the use of this instrument to recapitalise the cajas. 39

40 40

41 3. CORPORATE GOVERNANCE CONCEPTUAL FRAMEWORK Sound governance is critical to guarantee the long-term sustainability of any institution. Corporate Governance practices can take different forms and are affected by the political and social system in which they operate, the ownership structure of the institution and the process along which they are designed. Good governance of a company generally tries to connect (i) the way its board of directors and management exercise their functions and (ii) the interests of the company owners and other stakeholders (see OECD, 2004). Although this approach to Corporate Governance applies in principle to any kind of company, its scope focused initially on companies listed on a stock market. Thus, most existing codes of good governance address listed companies. This is a reflection of the growing separation between the company s management and its shareholders as a result of the development of modern securities markets. This notion of Corporate Governance also applies to financial institutions, but in their case the emphasis shifts towards the role played by these entities in the economy as a whole, in particular in i) deposit taking, ii) lending and iii) the functioning of the payments system. The systemic relevance of these functions implies that the Corporate Governance of financial institutions has a greater social dimension than in the case of the average non-financial company, a fact that has been dramatically highlighted by the international financial crisis. In this sense, the relevance of financial institutions good governance stems not so much from whether they are traded companies, but from the broader impact they have. 41

42 Indeed, deposit taking ultimately depends on the trust of savers in the financial institutions. This trust concerns not only the reward that those savers will receive for their deposits, but also (and more importantly) the possibility of withdrawing these deposits on the agreed terms. On the other side of the balance sheet, credit demand also depends on the confidence in obtaining reasonable terms of amount, cost, time and opportunity for the loans granted, in a transparent way. In both cases, we should bear in mind that savers and borrowers are numerous and diverse, and have in general a distant relationship with financial institutions. Thus, from the point of view of safeguarding their interests, their relationship with the management is even more remote than that of owners. As regards the payment system, its operation and efficiency also depends crucially on the trust by all participants: payment recipients, payment senders, as well as the entities operating the system. It follows from the above that sound governance of financial institutions responds to a variety of objectives (see Basel Committee on Banking Supervision/BCBS, 2006 and 2010b). Figure 2 below illustrates how these objectives interact. The listed objectives (sound management, efficiency in resource utilization and consumer protection) are obviously interrelated. They can also be categorized into two major groups: 1. Internal objectives, which refer basically to the sound management of the financial institution, in terms of profitability, efficiency and long-term growth. 2. External objectives, which relate to the relationship of the entity with its clients (savers and borrowers), investors and the society at large, in particular its contribution to the correct functioning and stability of the financial system. In the case of institutions having a financial inclusion objective this should also be taken into account. 42

43 Figure 2. Sound Governance of Financial Institutions OBJECTIVE: SOUND GOVERNANCE Good management incentives Incentives: - Profitability - Long term survival - Growth Efficient use of resources Limitations to - Clients - Society - Investors Protection of: Illegal/ harmful operations for the entity Excessive assumption of risks Financial stability Financial inclusion INTERNAL OBJECTIVES EXTERNAL OBJECTIVES Source: Own elaboration. Afi, Analistas Financieros Internacionales. From the perspective of WSBI, which is formed by a diversity of institutions belonging to a large number of countries (92), the issue of Corporate Governance cannot be isolated from the economic and institutional environment in which these institutions operate. To be able to draw appropriate conclusions for WSBI members, we need to consider therefore the social and political contexts of the variety of institutions that integrate the network. The connections between managers, owners, depositors and borrowers, crucial for financial institutions, become even more relevant when considering Access to Finance as an objective, which depends closely on the development of the financial system. All these interconnections can also be largely influenced by the political and social system, as shown in Figure 3 on the next page. 43

44 Figure 3. The interaction of the political and social systems (and other environmental elements) in the banking system's Corporate Governance POLITICAL SYSTEM POLITICAL SYSTEM SOCIAL SYSTEM Separation of powers Legal system Regulation Supervision/discipline Income distribution and power concentration Education and experience Access to capital markets - Market norms Acquisition by foreign entities - Rules home countries Banking crisis - Rules/norms improvement External environment of good governance Good governance of financial entities Ownership structure Conflicts of interests Transparency/stability Board of Directors Management Audit Stakeholders Source: Own elaboration. Afi, Analistas Financieros Internacionales. 44

45 As can be seen in the figure above, sound governance in financial institutions is closely linked to four aspects: 1. The development of a political system based on a proper separation of powers, in which the legal system supports an appropriate regulation of banks, including their supervision and discipline to avoid excessive risk-taking. 2. A social system that creates an adequate environment for the availability of sufficient human capital, with appropriate levels of education and expertise to ensure the sound governance of banking firms. This needs to be accompanied by mechanisms to avoid an excessive concentration of wealth and power. 3. The ownership structure of financial institutions is a very relevant factor in determining the potential conflicts of interest that may arise among owners and between them and the governing bodies. Transparency and stability of the ownership structure contributes, in general, to good Corporate Governance. 4. Finally, the external environment may contribute to sound governance, specifically in areas such as: a) access to domestic or international capital markets, to the extent that the rules or practices of those markets reinforce sound governance; ii) the influence of foreign entities on the national banking system, when they import sound governance standards from their home countries to their subsidiaries or branches in the host countries, and this contributes to improving the overall standards of the country through emulation; or iii) the adoption of codes of conduct or the improvement of existing ones, very often as a reaction to banking crises. 45

46 Table 5. Corporate Governance in the five selected Case Studies: Board of Directors Germany Kenya Peru Philippines Spain 10 Nomination of Board of Directors Composition of Board of Directors depends on Lander law and this differs from State to State. Generally speaking two thirds of the Members are appointed by the municipality/district, one third by the staff. 5 non-executive members and 1 executive member. All nominated by the Government. 7 members: 3 elected by the municipal representatives (2 by the majority, 1 by the minority), who cannot be members of the council; 1 by the Catholic Church; 1 by the Chamber of Commerce, 1 by COFIDE (second tier public bank) and 1 from the local association of small entrepreneurs. 8/9 "recommended" by the President of the country. The other is the Post Director. Full separation between Postal Corporation and Postal Bank. Each Caja has its own rules. On average, members, appointed by General Assembly ( members): depositors (average 36%), municipalities (25%), Regional Government (8%), founding entity (12%), staff (10%). Max. representation of public administration: 50%. Source: Own elaboration. Afi, Analistas Financieros Internacionales Sound governance and the different organizational forms A common analytical framework for the different organizational forms that constitute the WSBI membership would require taking into account a series of elements, such as the following: n Ownership of the institutions, in terms of, for example, voting rights, or the trading of property rights in the secondary market. In particular whether the latter are listed on a stock market has traditionally been regarded as an important element of market discipline, through which financial markets are supposed to instil elements of discipline to managers of listed companies. The recent crisis however has implied a considerable scepticism on the capacity of financial markets to perform efficiently such function ( market discipline ). 10 In July 2010, when this Report was in advanced stage of production, the Spanish Government approved a reform of the law regulating savings banks, with important implications in terms of corporate governance. 46

47 n n n At the same time, the distance and the potential conflicts of interests between owners and clients is a focus of debate, which is of course less relevant the closer they are. At the far end of the spectrum, in the mutual or co-operative models 11, when clients and owners can coincide, this conflict is eliminated [see Oliver Wyman (2008) for a review of the cooperative model in the financial sector]. More generally, the role of other stakeholders customers, employees and public administration (and in the end taxpayers) has been subject to intense debate (see for instance Walker Review, 2009). Depending on their nature, number and dispersion, these stakeholders objectives may be more or less likely to enter into conflict among themselves and with the owners objectives. The clarity and consistency of the objectives of the institution, as well as the diversity in the members of the board, are key elements in balancing these interests. Competition in other markets in which the entity operates may entail an additional discipline device. Particularly capital markets play a role in this regard, not confined to the trading of equity for shareholder institutions, but also other securities, hybrid instruments, fixed rate securities, etc, which normally entail some obligations in terms of transparency and Corporate Governance. The possibility that the entity has a credit rating (sometimes an obligation related to listing in certain markets) implies also certain transparency and Corporate Governance obligations. The labour market could also introduce elements of discipline, to the extent that attracting the best talents requires good Corporate Governance standards. The influence of regulation and supervision is a very important factor in the Corporate Governance structure, specifically from the point of view of the discipline imposed on the entity. In weak institutional environments banking supervision is very often the only source of pressure towards sound Corporate Governance. Nevertheless, as stressed by Mülbert (2010), the emphasis of banking regulation and supervision on the interest of depositors (and debtors in general) may conflict with that of owners. It is interesting to note in this regard that, according to Beltratti and Stulz (2009), banks with more shareholder friendly boards performed worse during the crisis. 11 According to WSBI data, 4 of its members are co-operative banks or their associations (Asociación La Nacional de Ahorros y Préstamos, Dominican Republic; Banque Populaire Caisse d Epargne/BPCE, France; Federación de Cajas de Crédito y Bancos de los Trabajadores, El Salvador; Cooperativa de Crédito para o Desenvolvimento Rural, Mozambique) and 5 of them are mutual banks or their associations (Federación de Mutuales de Ahorro y Préstamo de Costa Rica; Asociación Popular de Ahorros y Préstamos, Dominican Republic; Dongbu Savings Bank, Korea; Korean Savings Banks Group). 47

48 Banks in countries with stricter capital requirements regulation and with more independent supervisors performed better. This is related to the debate on the possibility of excessive risk assumption in banks too focused on short-term shareholder value, and the need for financial regulation to correct this emphasis in favor of other stakeholders. Figure 4. Ownership structure, other stakeholders and Corporate Governance OWNERSHIP STAKEHOLDERS Negotiability - Number/dispersion - Clarity/compatibility of objectives Separation owner-client Voting rights - Separation of decision and risk assumption - Decision-making - Agency cost incentives Members/owners options: - Voice - Exit - Organization structure: Regulation/ discipline Market competition - Labor market - Capital market - Rating Efficiency Residual risk Control & accountability GOOD GOVERNANCE OF THE FINANCIAL ENTITY Source: Own elaboration. Afi, Analistas Financieros Internacionales. 48

49 The first two elements (the ownership structure and the role of stakeholders) determine the formal decision making process in financial institutions. Particularly relevant is the connection between the decision-taking process and risk assumption resulting from these decisions. The global financial crisis has highlighted the need for consistency between ensuring an integral view by the Board of the risks facing the institution while, at the same time, granting a certain independence of the Chief Risk Officer (CRO). The latter should have at its disposal adequate means to develop this important function and should report directly to the Board, where the ultimate responsibility on the integral view of the institution lies (see Walker Review, 2009). This raises two questions: (i) the agency costs in the organization, which generally depend on the options available to the owners in reacting to management decisions contrary to their interests (voice and exit from the entity); (ii) the design of the incentives, including the remuneration of directors in the board and management. A considerable debate has taken place recently on incentives and remuneration in banking institutions (see BCBS, 2010a), as a result of which principles for avoiding excessive short-term focus in incentives have been adopted. These principles seek to promote appropriate compensation practices to create the right incentives for effective risk management and avoiding excessive risk taking. These practices must be approved by shareholders and be subject to oversight by supervisors. In turn, the organizational structure must be analyzed considering elements such as efficiency, the residual risk (which owners generally bear), control and accountability. Without these elements sound governance of the financial institution would not be well founded. The organisational structure of WSBI members can be grouped around the following models: government-owned banks, savings banks as public institutions, postal savings institutions, mutual or cooperative banks, private banks (listed or not listed) and foundations. This diversity of organizational forms raises the issue of whether good Corporate Governance features are common for all these types or vary among them. In general, Corporate Governance depends on ownership structures, but some general good practices are applicable to all these types of institutions, especially when considering that (i) most codes and standards originate in common banking regulation and supervision and (ii) they share similar access to finance objectives. 49

50 3.2. Public banks Public banks are of special interest, given their relative importance in the WSBI membership: they represent 57 percent of WSBI members, and 55 percent of their assets. The BCBS (2006 and 2010b) subjects them to the same general principles of sound governance as the ones that apply to any other bank, because the Committee believes that state-owned banks may face many of the same risks associated with weak Corporate Governance than private banks (paragraph 19 of BCBS, 2010). Therefore, the Basel Committee concludes that the general principles of sound corporate governance should also be applied to state-owned or statesupported banks, including when such support is temporary (eg during the financial crisis that began in mid-2007, national governments and/or central banks in some cases provided capital support to banks) 12. This does not preclude the possibility to determine explicit sound governance principles for government-owned entities, as described by OECD (2005) for public companies in general. The BCBS documents (2006 and the 2010b) also note three specific principles relevant for government-owned banks, which are: n n In this type of bank a potential conflict of interest could take place if it is both owned by and subject to banking supervision by a state institution. Should this be the case, then there must be a full administrative separation of the ownership and banking supervision functions to minimize political interference in the supervision activities (paragraph 59, Principle 3 of BCBS, 2010). Under a sound regulatory framework, the role of the supervisor is essential in this regard. For instance, in the case of BancoEstado (Chile), a government-owned bank member of WSBI, the risks of political interference are partially mitigated by a rigorous prudential supervision by the Chilean banking supervisor, as stressed by Rudolph (2009). Governments should not participate in the daily management of public banks, but respect the independence of the board. The latter must maintain its responsibilities outside political influences that could lead to conflicts of interest (for example, when directors explicitly represent political interests or are public officials). 12 Most public banks considered in this section are state-owned institutions, with the important exception of the German Sparkassen, where the Municipality is the Traeger a German term that can be translated as supporting or responsible institution, but not the owner. See Annex 2. 50

51 n However, this does not mean denying the right of the government as an owner to set the bank s overall objectives (paragraph 20, Principle 1 of BCBS, 2006). Where a bank is state-owned, disclosure policy should include an ownership policy that defines the overall objectives of state ownership, the state s role in the Corporate Governance of the bank, and how it will implement its ownership policy (paragraph 50, Principle 7 of BCBS, 2006). It is important in this regard to stress the need for a clear definition of the mission and objectives of public banks. Amongst government-owned banks, postal savings institutions are an important category of WSBI members, especially in Africa. A number of them are currently facing institutional reform with a view to turn them into proficient and competitive financial institutions, acting as key intermediaries for financial inclusion, across the country. A crucial condition to reach this objective is the development of efficient and transparent mechanisms, which will ensure full independence of the management and Board of Directors from political influence. The government's influence over the banking system is not confined to ownership. As mentioned above, it has a significant influence through regulation, and can also have an impact by adopting other controls or conditions, such as the establishment of mandatory ratios and/ or limits on operations, either to their amount or the prices (e.g. interest rate ceilings). The influence of the state in the banking system is not only a question of sound governance, but also one of efficiency. Thus, it is necessary to avoid any sort of undue influence that may cause a deterioration of the efficiency (and therefore the long term stability) of the financial system, such as (i) an unfair competitive advantage for public-owned banks, (ii) a bias in the financing towards the public sector, (iii) the provision of liquidity to the public sector in privileged terms or (iv) the lack of independence of the board of directors and/ or the management of public banks. In the particular case of Postal Banks, it is crucial to put in place efficient and transparent mechanisms which will ensure full independence of the management and Board of Directors of the postal savings institution from political influence and clear supervision rules and responsibilities (WSBI, 2010). 51

52 3.3. Mutuals and cooperatives This organizational structure presents three characteristics very relevant for Corporate Governance: 1. The voting rights may be not proportional to the size of the stake (for example, one person, one vote). 2. There is no separation between customer and owner, as ownership rights can accrue by becoming a customer. 3. Each owner has a claim to residual net worth, which is usually non exclusive : typically new members can join on equal terms to those of previous ones. Ownership claims are not explicit and marketable, as in a limited company. If owners are also the customers, the implication is that the person with whom business is done is the person for whom business is done (Penrose, 2004). This has two important implications for Corporate Governance: (i) its definition is less clear, because of the ambiguity of the firms objectives in the case of mutuals, due to the absence of an equivalent of maximizing shareholders value; and (ii) the main types of Corporate Governance conflicts arise among the owners, since their interest tend to be different. The non exclusive claim implies that a mutualist cannot prevent that the mutual does business with new customers, who join the mutual with the same rights than the former mutualists. Its capital is built from accumulated profits, leaving aside subordinated debt and similar financial instruments. This has several implications: 1. Market discipline is inexistent or very weak. 2. There is no distribution of profits to owners, except the possibility to dedicate part of these profits to improve the products in favor of the owners, as it is typical in insurance mutuals. 3. Mutuals enjoy a theoretical advantage in the cost of capital, in the sense that it does not need to be explicitly remunerated. More details on Corporate Governance of mutual banks can be found in Llewellyn (2007), in particular for British building societies. Although these entities are not members of WSBI, they are a good example of mutual banks. 52

53 Cooperatives are similar to mutuals as far as the absence of separation between customer and owners is concerned, but in a lesser measure, because cooperatives may have a limited business with customers that are not owners. Also, they may have externally-held capital, although, in general, in a non-marketable form. BOX 3. PHILIPPINES POSTAL SAVINGS BANK (PPSB) Corporate Governance The only shareholder of the PPSB is the Philippine Postal Corporation (PPC). The PPSB is a separate legal entity, with full autonomy under the direction of its own board of directors, its own balance sheet, and profit and loss accounts, in accordance with World Bank recommendations (see World Bank, 2006). This is in line with good Corporate Governance practice, since a postal organization and a bank are completely different businesses that require different management skills. However, the complete separation is not benefiting PPSB from a capitalisation point of view. Only 50 percent of the PPSB authorized capital (1- billion pesos) has been subscribed by the PPC and only 30 percent was paid up. Retained earnings over recent years have increased this figure to 40 percent, but the accumulation of profits is a very slow process to increase capital. At the present pace it will take 25 years to reach the level of the authorized capital. In the Philippines public banks do not provide in general any additionality to the private sector; government banks are rather competitors of private banks. Besides the PPSB there are many other government-owned banks: Development Bank of the Philippines (DBP), Land Bank of the Philippines (LBP), Veterans Bank (now private) and Al Amanah (an Islamic Bank). This diversity is not strictly based on different missions, but rather on history. They were born to address a certain market failure, but in general this is no longer the case. The possibility of merging some of them has been discussed several times, but no decision has been made. The case of the Philippines seems to depart from good practices in this regard, which in general recommend for public banks to have a clear mission related to an identified market failure, especially if there are several of them operating in the country. 53

54 PPSB has a very comprehensive Corporate Governance Code, and the practices are in line with central bank and SEC (the market regulator) guidelines. The Philippines banking system benefits from having a banking supervisor very concerned with Corporate Governance. PPSB approach to Corporate Governance is in accordance with international best practices, but not particularly tailored to Access to Finance objectives. Access to Finance PPSB is a small institution limited in its outreach by the constraint of not having the capacity to use the Post Office network of branches, which is normally considered as the main advantage of postal banks. Out of the 2,817 branches that the Post office has, only 25 are used as PPSB branches. There are two reasons for this. First, there is an IT connectivity problem in the postal network and second PPSB capital is considered insufficient by the Central Bank to allow for expansion. For the PPSB to be able to use the post office network, it will first need to find a solution to the capital increase problem. The plan is also dependent on the central bank forthcoming regulation on third party entities as agent banks, which includes a reference to the Postal Bank. This regulation will probably relax the conditions for the use of agents, which may benefit the outreach capacity of PPSB. Corporate Governance and Access to Finance The mission of PPSB is to be a strong and dynamic national institution that will mobilize savings and promote entrepreneurship to widen economic opportunities. Provide the Filipino people with a full range of professional banking and financial services accessible in all areas of the country and promote the values of thrift, industry and prudence especially in the youth. This statement includes general references to Access to Finance. These general guidelines have not been translated, however, into specific financial inclusion policies or objectives. Thus, there seems to be certain disconnect between the Corporate Governance Code and the financial inclusion objectives as stated in the mission of the institution. 54

55 3.4. Foundations Foundations do not have owners but founders. Whereas owners objective is, in general, to obtain a profit from an initial investment, founders do not intend, as a rule, to recover their profits or net worth. As time passes, founders can disappear, or the weight of their initial endowment can become very small as compared to the total own funds, in particular if the pace of accumulation of reserves is very rapid. For this reason, it is typical that over time these organizations tend to be influenced by the public administration, as has been the case of the Spanish savings banks, including for the appointment of the members of the Board. In this case, the Corporate Governance problems of these institutions tend to converge with those of public banks (see above), with a certain disadvantage from the point of view of the mechanisms for recapitalisation. BOX 4. SPANISH SAVINGS BANKS (CECA) Corporate Governance Spanish savings banks are private foundations, profit making financial institutions designed to foster economic and financial development in their respective areas, fighting social and financial exclusion and return profits to society. All these objectives are subject to a financial performance according to market standards. Some specificities of Spanish savings banks are the absence of owners and the composition of their governing bodies, appointed by a plurality of stakeholders representing the community in which they operate: depositors, staff, municipalities, regional government, the founding entities and other private bodies of the community 13. Access to Finance Spanish Savings Banks have continuously promoted Access to Finance from a geographic and sectoral dimension, as a result of their extensive network of branches and their specialized attention to retail clients (households and SMEs) in their area of influence. 13 A Law approved in July 2010, when this report was in advance stage of finalization, included a series of changes in the Corporate Governance of savings banks, including the limitation to 40% of members of the Board appointed by the public sector. 55

56 The greater capillarity of the savings banks network vis-à-vis that of banks is reflected in the fact that in 14 percent of rural towns savings banks provide the only banking branch. On the sectoral dimension, savings banks meet 56 percent of the households demand for finance, 43 percent of SMEs finance and over 53 percent of overall household savings. Savings banks have also introduced new products to attend new needs of otherwise excluded population, such as the immigrants demand for remittances services. This is the long term result of the Savings Banks strategy of fighting against financial exclusion in Spain, structured around three main pillars: geographic Access to Finance, adoption of new products and services to new realities, and financial education. From a banking industry perspective, the existence of Savings Banks has ensured a high level of competition in the Spanish banking industry, despite the profound concentration process it underwent in the 1990s. Thanks in part to Spanish savings banks, a high degree of efficiency has been compatible with a high level of bancarization. Corporate Governance and Access to Finance A key principle of financial regulation since the reform in the 1970s is to apply the same treatment to savings banks and commercial banks. This reality, combined with the highly competitive banking sector in Spain, has forced savings banks to maintain their profitgenerating activity close to the level of banks, and has imposed greater responsibility to the savings banks governing bodies in their mission of balancing the institution s financial objectives (profitability) with the objective of facilitating Access to Finance. Although each savings bank has its own statutes and its own mechanisms of representation, one common feature is the presence of representatives of the Municipalities in the Board. To the extent that they have an interest in ensuring Access to Finance in their town or region, this has been reflected in the high capillarity of the network of branches. Without the savings banks, a number of smaller towns in Spain would probably not have any banking presence, with the ensuing cost of financial exclusion for a vulnerable segment of the population. 56

57 3.5. Good Corporate Governance practices in banking institutions What are the practical implications of the above discussion in the Corporate Governance of WSBI members, whatever their legal form? Corporate Governance of financial institutions concerns mainly: i) the council or governing body, ii) the management, iii) the supervisory bodies (risk management, compliance with the applicable laws and regulations), (iv) auditing (external and internal) and v) transactions with parties related to the entity (see BCBS, 2006). The main reference for sound Corporate Governance practices of banking institutions is the set of Principles defined by the Basel Committee on Banking Supervision, in 2006 and revised in October Table 6. Sound Corporate Governance Principles. BCBS (October 2010) A. BOARD PRACTICES Principle 1 Principle 2 Principle 3 Principle 4 Board s overall responsibilities The board has overall responsibility for the bank, including approving and overseeing the implementation of the bank s strategic objectives, risk strategy, Corporate Governance and corporate values. The board is also responsible for providing oversight of senior management. Board Qualifications Board members should be and remain qualified, including through training, for their positions. They should have a clear understanding of their role in Corporate Governance and be able to exercise sound and objective judgment about the affairs of the bank. Board's own practices and structure The board should define appropriate governance practices for its own work and have in place the means to ensure such practices are followed and periodically reviewed for ongoing improvement. Group Structures In a group structure, the board of the parent company has the overall responsibility for adequate Corporate Governance across the group and ensuring that there are governance policies and mechanisms appropriate to the structure, business and risks of the group and its entities. 57

58 B. SENIOR MANAGEMENT Principle 5 Under the direction of the board, senior management should ensure that the bank s activities are consistent with the business strategy, risk tolerance/appetite and policies approved by the board. C. RISK MANAGEMENT AND INTERNAL CONTROLS Principle 6 Banks should have an effective internal controls system and a risk management function (including a chief risk officer or equivalent) with sufficient authority, stature, independence, resources and access to the board. Principle 7 Risks should be identified and monitored on an ongoing firm-wide and individual entity basis, and the sophistication of the bank s risk management and internal control infrastructures should keep pace with any changes to the bank s risk profile (including its growth), and to the external risk landscape. Principle 8 Effective risk management requires robust internal communication within the bank about risk, both across the organisation and through reporting to the board and senior management. Principle 9 The board and senior management should effectively utilise the work conducted by internal audit functions, external auditors and internal control functions. D. COMPENSATION Principle 10 The board should actively oversee the compensation system s design and operation, and should monitor and review the compensation system to ensure that it operates as intended Principle 11 An employee s compensation should be effectively aligned with prudent risk taking: compensation should be adjusted for all types of risk; compensation outcomes should be symmetric with risk outcomes; compensation payout schedules should be sensitive to the time horizon of risks; and the mix of cash, equity and other forms of compensation should be consistent with risk alignment. E. COMPLEX OR OPAQUE CORPORATE STRUCTURES Principle 12 The board and senior management should know and understand the bank s operational structure and the risks that it poses (ie know-your-structure ). Principle 13 Where a bank operates through special-purpose or related structures or in jurisdictions that impede transparency or do not meet international banking standards, its board and senior management should understand the purpose, structure and unique risks of these operations. They should also seek to mitigate the risks identified (ie understand-your-structure ). 58

59 F. DISCLOSURE AND TRANSPARENCY Principle 14 The governance of the bank should be adequately transparent to its shareholders, depositors, other relevant stakeholders and market participants. Source: BCBS (2010b): Principles for enhancing Corporate Governance. For the purpose of this study, the main interest would be in identifying a link between sound Corporate Governance practices and Access to Finance. The latter obviously depends also on factors beyond the Corporate Governance of the banking institutions. However, to the extent that Access to Finance is part of their objectives (as in the case of WSBI members), Corporate Governance practices aimed at ensuring that management fulfils these objectives should establish a link between both. Without prejudice of the observation of the generally agreed Corporate Governance Principles, and according to the literature (see annex 1) and the statistical evidence (see section 5), some practices that could help in establishing this link with Access to Finance are for example the following: 1. The clarity in the definition of the mission and objectives of the institution. For savings banks, a commitment to facilitate access to financial services is typically stated in the relevant savings bank legislation, in their statutes (in the case of publicly or mutually-owned savings banks), or in their mission statement (in the case of socially committed private retail banks). 2. Regulatory provisions or good practices to avoid undue interference in the policies of the institution, by the Government, political groups, pressure groups or others. 3. The size and composition of the board, including the representation of the diverse stakeholders having an interest in the institution and the balance between different groups (gender balance, territorial balance). 4. An appropriate distribution of responsibilities between the different decision- making levels. In particular, the separation between the Chairperson and the CEO (Chief Executive Office) is generally considered as a good practice. 5. The existence of internal or external controls, in the form of internal auditing, other internal control mechanisms (such as an internal Corporate Governance code of conduct), a rating by an external agency or an external audit are also signals of good Corporate Governance practices. 59

60 Of particular concern is the control of the conflicts of interest between the institution and their administrators, managers or workers. 6. The transparency on the policies and activities of the institution, including the regular publication of financial statements and similar reports, is also a standard element in Corporate Governance evaluation. All these aspects will be evaluated in section 5 for WSBI members, in comparison with several measures of Access to Finance. 60

61 4. ACCESS TO FINANCE CONCEPTUAL FRAMEWORK Access to Finance is an increasingly relevant policy objective, especially in emerging and developing countries, given its impact on poverty alleviation, financial stability and economic welfare. The recognition of financial inclusion as one of the main pillars of the global development agenda in the G-20 summit in Seoul, in November 2010, is a signal of its prominence as a policy objective, which was manifested in a concrete action plan and a Global Partnership for Financial Inclusion. However, the precise measurement of Access to Finance is difficult, given its multiple dimensions. This section focuses on the relevance, definition and measurement of Access to Finance and introduces the specific variables that will be used in the quantitative analysis in section 5. The Santiago Declaration adopted by the WSBI members during their 22nd World Congress (2009), reaffirmed their long term commitment to a common objective: to contribute to achieving a broader degree of financial inclusion in an increasingly globalized world 14. WSBI members define financial inclusion as the provision of access to appropriate, convenient, usable, valuable and affordable financial services and products to the widest part of the population 15. In developing countries, financial inclusion involves delivering basic banking services to the unbanked, low income population. In developed markets, Access to Finance is related to the prevention of financial exclusion of the most vulnerable parts of the population

62 In developing economies, Access to Finance is considered a critical condition to break the vicious circle of poverty. In advanced industrial economies, the topic of financial exclusion is firmly integrated in a wider debate about social exclusion and its welfare costs, in particular in the case of rural areas, immigrants or minorities whose integration in the formal financial system is complicated by geographic, social or cultural obstacles. Savings banks are critical in promoting financial inclusion. Previous WSBI studies conclude that (i) it is difficult for developing and transition economies to move towards full Access to Finance unless they have strong savings banks or other public-purpose bank with an explicit mandate to improve Access to Finance; and (ii) savings banks are also important to maintaining access and to provide products accessible to the socially and economically excluded in advanced economies, where these institutions remain close to regions and customer groups not seen as a priority for other types of banks 16. WSBI members commitment in favour of financial inclusion has traditionally been built on the following principles and practices that have proved effective: n n n n The promotion of accessible, small-scale and basic services as part of their regular banking offer, which implies the development of affordable and convenient savings accounts, as well as the support of microfinance as a finance tool for the low income population both in developing and industrial countries. The continuing construction of a large distribution network supporting proximity banking to both assess and attend clients specific needs, including those in low populated, economically disadvantaged and remote areas. The strengthening of the social and welfare investment activities in their communities, as part of their Corporate Social Responsibility (CSR) activities, to support and complement the financial inclusion efforts. The recognition of the importance of financial education for a better and broader financial inclusion. 16 Perspectives 49, January 2006 Access to finance What does it mean and how do savings banks foster access. 62

63 4.1. Financial deepening and improvement of socioeconomic conditions The objective of the financial system is the efficient allocation of saving towards the most profitable investment opportunities, while ensuring monetary and financial stability, as well as the security of the payment systems. Attaining an appropriate level of Access to Finance is the main objective of WSBI members, thus contributing to a deep financial system, accessible to most of the population, and an enabler of economic growth and welfare. The efficient allocation of saving is not possible if a big portion of the population is excluded from the formal financial system. Access to financial services is indeed an essential driver for economic growth in both developing and industrial countries, allowing people to increase the benefits from their economic activities and to move away from short-term decision-making to a more efficient inter temporal allocation of resources. Savings banks contribute also to the diversification of the financial system. Accessing financial services is a key condition for poverty alleviation, social and economic progress and sustainable development, as represented in Figure 5. Figure 5. Economic development and use of financial services Source: World Bank (2008), Finance for All. Policies and Pitfalls in Expanding Access. 63

64 Financial sector policies that encourage competition, provide the right incentives, and help overcome access barriers are central to attaining the abovementioned objectives. A financial system that lacks penetration beyond the higher income segments of population forces the majority of people to rely on less efficient, riskier and more expensive informal financial channels. WSBI members contribute to enhance formal access to financial services. This is the case for example through microfinance activities, which represent a significant part of savings banks business, especially in Latin America, where three WSBI members have been forerunners of the microfinance industry in their respective countries: Banco BCSC, formerly Banco Caja Social, in Colombia, the Cajas de Crédito, represented by FEDECREDITO in El Salvador and CMACs in Peru (see Box 4) 17. BOX 5. CAJAS MUNICIPALES DE AHORRO Y CRÉDITO (CMACS) IN PERU Corporate Governance The supreme decree that regulates CMACs establishes as governing bodies the board of directors and the joint management. A very interesting feature of CMACs is that despite having only one shareholder (the Municipality), the appointment process of the Board of Directors involves different stakeholders. Thus, the board consists of seven members: three elected by municipal representatives (two elected by the majority and one by the minority, neither of them town councillors), one from the Catholic Church, another from the Chamber of Commerce, and another from COFIDE (Corporación Financiera de Desarrollo, a second tier public bank) and finally one from the local association of entrepreneurs representing the MSME business sector. This plurality limits political interference since the board represents the interest of different stakeholders, acting as checks and balances mechanism. 17 For more information on WSBI members microfinance activities see Perspectives 59, July 2009 Beyond Microcredit: the role of savings banks in microfinance %20finallowres.pdf. 64

65 The board does not have any executive function, being the Joint Management responsible for the economic, financial and administrative functioning of the Caja. The fact that the governing bodies of the Cajas are established by law implies that their Corporate Governance is very stable and protected from the temptation of opportunistic changes; on the other hand, this structure lacks the flexibility to react to new, unforeseen requirements. Access to Finance The mission of CMACs is to contribute to the development of the community. Microenterprises (MES) are the dominant form of business and the natural clients of CMACs. The clear specification of financial inclusion objectives in the mission of CMACs is a factor that also explains their concentration in the MES clients. However, the recent increase in competition in the MES segment by commercial banks, MFIs and rural cajas led CMACs to enter the traditional banking segments of commercial and consumption credit. This does not alter the Cajas financial inclusion policies. It is just natural that CMACs try to compete in the market and satisfy their clients needs as they grow and transform themselves into bigger enterprises. Corporate Governance and Access to Finance According to the law, at least 50 percent of the profits have to be retained for capitalisation, and the rest can be distributed to the Municipality for social and infrastructure projects according to the priorities established in the Provincial Development Plan. The use of the distributed profits for social and infrastructure projects ensures that the activity of CMACs contribute to the progress of the community (although the mechanisms for controlling this use are in general weak). There is a drawback to a generous profit distribution, since CMACs can only be capitalized through retained profits. Because the distribution is decided by the Board, composed by representatives of the Municipality, they tend to distribute the maximum percentage. A remarkable example of the added value of the Board composition is the way COFIDE has fostered better capitalisation in several CMACs by providing funding in the form of subordinated debt with the condition that CMACs retain at least 75% of the profits. 65

66 This measure will support CMACs to advance further in their missions, since better capitalized Cajas can offer more credits and expand their outreach to uncovered areas. The case of CMACs provides an example of proactive revision of the regulation to allow Cajas to adapt to the needs of the market and remain relevant players. Cajas have been authorised to operate outside their region since This revised mandate expands the area of action of CMACs, providing financial services to underserved regions, and allowing CMACs to diversify their risks and to develop a more sustainable business model Access to Finance and Financial Stability According to the traditional view, Access to Finance triggers a virtuous circle that through risk diversification, efficiency gains and less dependency on external capital flows leads to higher economic growth. At the same time, however, there is consensus around the idea that the financial sector tends to exacerbate the cyclical fluctuations of the economy, through the well known financial accelerator mechanism. The international financial crisis is a clear example of this potential for amplification of economic fluctuations through the financial system. How to reconcile these visions? Is there a trade-off between financial development (or financial inclusion) and financial stability? On the one hand, over the recent period emerging and developing countries have been able to reconcile financial development (as evidenced by high credit growth) with gains in financial stability (as shown by decreasing spreads or stress indices, and by the resilience of these countries to the international financial crisis). On the other hand, in the case of developed countries the most sophisticated financial systems have been subject to higher volatility and pro-cyclicality. In particular, as a result of the subprime crisis in the US one popular view has been that providing Access to Finance for lower segments of the population entails heightened risks for financial stability. One possible way to reconcile these views is that there might be a tradeoff between financial access and financial stability in the short term, but both tend to be complementary in the long term. 66

67 In other words, sustainable financial stability requires in the long term a deep and efficient financial system. And a financial system that excludes ample segments of the population cannot be considered either efficient or stable. The idea that the US subprime problems were a result of a financial inclusion process requires in any case important nuances. The factors behind the crisis are much more related to wrong incentives in the mortgage credits origination process of one particular model of banking (the so called originate to distribute model), inadequately supervised, amplified by a complex framework of credit derivatives and structured products, blessed by credit rating agencies and propagated to the rest of the world due to the opacity of these products and the negligence in risk management of some of the most important global banks. The experience of many emerging and developing countries shows, on the other hand, that it is possible to foster Access to Finance while maintaining adequate risk controls. Savings banks, cooperatives and micro-finance institutions in these countries have been able to contribute to financial deepening while at the same time fostering financial stability. In fact, in contrast with the pro-cyclicality of commercial banks which tend to inflate the credit bubble in the good times and exacerbate the credit crunch in the bad times, institutions whose objective is facilitating Access to Finance are more stable in their policies and less sensitive to the changing mood of global financial markets. This tends to smooth credit fluctuations and contributes to financial stability. As Chris De Noose, the WSBI Managing Director, recently stated, most WSBI member banks have been generally resilient to the financial crisis, and the focus on supporting local markets and the real economy leads to a long-term vision and partnership which greatly reduces the impact of the volatility of financial markets on the institutions. At the same time, though, the economic crisis that has affected the world has of course had an impact on the activities and life of our core clientele households and small entrepreneurs. Our banks do their utmost to provide support in these difficult times. As a result of this crisis, a program of reforms of international financial regulation is under discussion, to improve risk management and strengthen the capital base of financial institutions. These reforms are not addressed at small institutions in developing and developed economies specialised in Access to Finance, since these institutions were not affected by the failures that led to the crisis. 67

68 But there is a certain risk that the reforms, if applied universally, could lead to a move back in the financial inclusion process. It is important in designing the reforms to keep in mind what went wrong. Segments or institutions that did not fail do not need to be repaired. And financial inclusion objectives need to be pursued with determination, avoiding putting them aside by the trend to emphasise financial stability The double bottom line of WSBI members Savings banks are by far the largest representatives of double bottomline institutions that explicitly target unbanked and underserved customers. According to WSBI estimates, these double bottom-line institutions provide around 1.4 billion accessible accounts across developing and transition economies, three quarters of which (some 1.1 billion accounts) come from savings banks 18. Since 2004, WSBI has published three reference papers 19 related to Access to Finance. They show the important role savings banks play in the provision of financial services: savings, payments, credit and to a lesser extent, insurance; how large their distribution networks are, and how close is the relationship with their customers. All the above has led savings banks to become a reference in their nature as double-bottom line financial institutions. Savings banks have long proved that it is possible to ensure long-term sustainability of the institution while facilitating Access to Finance, and that outreach does not have to be attained at the expense of profitability. Previous research by WSBI has identified, as a critical factor in maintaining the balance between both objectives, the ability to keep unit costs under control, which is closely related to having products that are simple to understand and to run and that allow for certain profitability even without high volumes. 18 Perspectives 52, September 2006 Savings banks and the double bottom line A profitable and accessible model of finance, Research_(ESBG_only)/Perspectives%2052.pdf. 19 WSBI Perspectives 49, Access to Finance What does it mean and how do savings banks foster access, January 2006; WSBI Perspectives 52, Savings Banks and the Double Bottom Line A profitable and accessible model of finance, September 2006; WSBI Perspectives 56, Who are the Clients of Savings Banks A poverty assessment of the clients reached by savings banks in India, Mexico, Tanzania and Thailand, April 2008, accessible from 68

69 The following table shows how the WSBI members under study promote financial inclusion with three different activities: density of their branch network (proximity banking), special products for underserved population, and innovative products. Table 7. Access to Finance in the five selected Case Studies Proximity Banking Special products for unbanked population Other products and services Germany Yes, present even in less developed regions. Yes, evolved gradually to adapt to changing customers needs. Branches for young people; financial education at schools; special personalized attention for the senior; microlending for the long term unemployed. Kenya Operates through the postal network. Agreement with M-PESA and other ATMs. Low requirements to open an account (zero minimum balance in some cases). Enrolled in the Bill & Melinda Gates Foundation Program aimed at doubling the number of accounts for poor people in five years. Peru Agreements with Agents and Banco de la Nacion, a public bank with presence in rural areas. Innovative in their product offering (microfinance technologies). In cooperation with the IDB, mortgage loan program that targets home purchases with moderate income. Philippines Limited, only 25 branches (no access to post office branches). Some products: micro - finance, remittances, and SME finance, in particular in the transport sector. Financial education programme. Spain Yes, 56% market share. (provision of credit). Cajas the only financial institution in 14% of Spanish municipalities. Yes: remittances services, pledged loans. Microcredits through Obra Social. Commitment with financial education. Source: Own elaboration. Afi, Analistas Financieros Internacionales. 69

70 4.4. The dimensions of Access to Finance The World Bank and UK DFID have identified four core dimensions of Access to Finance (Claessens, 2005), in which savings banks score systematically well 20. One dimension concerns the difference between access and usage, around which there is a permanent conceptual discussion, since access is more difficult to measure and is, by definition, larger than usage. In fact, being underserved does not necessarily mean lack of access, but could be the result of a conscious choice. This is of course related to the cost of the provision of financial services, which could explain the reluctance of certain segments of the population to enter the financial system. The simple and affordable products offered by savings banks are useable for even low value and irregular financial needs. The second identified dimension is whether access operates at an individual or household level, and how to measure it. There is now a common position, after much research and discussion, to consider the adult individual, and not the overall household, as the unit of response for surveys on Access to Finance. The third dimension is whether the provision of financial services falls in the category of formal/regulated, informal/unregulated, or somewhere in between. As mentioned before, low-income segments of the population may choose to use informal financial instruments even though they have access to formal services, because the former offer more flexibility and convenience, although they may lack the quality, security, leverage potential and sustainability of formal channels. Information requirements related to AML/CFT could also increase the overall cost of formal vs. informal financial services. WSBI members have innovated with financial products and services by bringing informal features to the formal segment, without compromising accessibility. Such is the case of the Basic Savings Accounts offered by BANSEFI in Mexico, and the use of agents (Non Banking Correspondents, NBCs) in several emerging and developing countries such as the Caixa Económica Federal in Brazil and some of the Peruvian CMACs. 20 Perspectives 52, September 2006 Savings banks and the double bottom line A profitable and accessible model of finance, (ESBG_only)/Perspectives%2052.pdf. 70

71 The fourth dimension refers to the type of products a financial provider offers to its clients, and how they respond to the needs of households and firms. Many savings banks have products to satisfy the full spectrum of customers functional needs, and are continuously working towards incorporating new products and services. This is for example the case of the savings banks efforts to support the financial integration of migrants through the provision of high quality and fair value remittance services by implementing the WSBI International Remittances Capability Agreement (IRCA), a common platform to support the development of these services The challenge of measuring Access to Finance Measuring Access to Finance entails conceptual as well as statistical problems. The Financial Access 2009 report by the Consultative Group to Assist the Poor (CGAP, 2009) uses new data from a survey of financial regulators from 139 countries to estimate the number of unbanked adults in the world 21. Their measure is the result of counting the total number of deposit accounts in the 139 countries and then dividing by three (considered this number to be an estimate of the average number of deposits per banked adult). Using this approach the report obtains a figure very similar to results obtained by other researchers: 2.8 billion of unbanked adults, close to the 2.5 billion estimated by the Financial Access Initiative see Chart 3). Beyond the estimate of the number of actual users of financial services, it is still a challenge to define what the best indicators are for measuring overall financial access. The ideal is probably using comparable and disaggregated information (by country, location, level of income, year) on the total number of individuals, households and firms that are actually saving, receiving credit, or being insured by formal or informal financial institutions. A fairly consistent measure of Access to Finance would be the number of depositors in a country, but this figure is rarely available either, being usually approximated by the number of total deposits per 1,000 adults, to make it comparable across countries. 21 See also Kendall, Mylenko and Ponce (2010). 71

72 Chart 3. Percent of Total adults who do not use formal financial services by region Source: own elaboration from Financial Access Initiative ( The average size of deposits is also considered a relevant indicator for access. The rationale is that, as the financial system reaches progressively lower segments of the population, the accounts tend to have a smaller average size. This relationship may be affected by the existence of dormant accounts, the co-existence of household and business accounts, and variations on the average number of deposits that a person holds, estimated by CGAP, as mentioned above, in 3. Also, to facilitate international comparison, the average size of deposits is corrected by per capita income, as an indicator of the countries level of development. As in the case of deposits, a higher average loan size is generally interpreted as reflecting a bias towards higher income customers. As financial deepening advances and financial markets develop, more people have access to credit and the size of the average loan (relative to the country s per capita income, as in the case of deposits) decreases. For the purpose of the present study, and in line with other international reports, the three abovementioned indicators of Access to Finance are used: (i) the number of deposits per 1,000 adults, (ii) the average size of deposits and, for those WSBI members that provide credit, (iii) the average size of loans. Table 10 presents a summary of the relevant data on Access to Finance provided by the five selected Case Studies. 72

73 Table 8. Access to Finance in the five selected Case Studies Germany Kenya Peru Philippines Spain Total Loans (million ) 741,438 n/a 1, ,517 Total Deposits (million ) 878, , ,382 Number of deposits (million) Amount of loans to SMEs 144,991 n/a n/a (million ) Amount of loans to individuals 290,203 n/a n/a (million ) Total Assets (million ) 2,632, , ,239,596 Market share of total assets 34.0% 2.0% 4.4% 0.1% 40.4% Number of Outlets 15, ,985 Average Deposit ( ) 8, ,450 Average Loan ( ) n/a n/a 2,000 1,000 63,000 Deposits / 1,000 adults ( ) 1, ,139 Source: own elaboration from WSBI data. 73

74 74

75 5. STATISTICAL EVIDENCE After establishing in previous sections the theoretical framework of the relationship between Corporate Governance and Access to Finance, as well as the connection with the five case studies, this section provides a quantitative measure of this link. Finding empirical evidence that supports this link is, however, not straightforward. There are three main reasons: (i) estimating Corporate Governance quality requires defining it, setting a standard and calculating the deviations; (ii) the measurement of Access to Finance is also difficult, because of its many dimensions; and (iii) the complexity of identifying all the relevant variables that make this connection meaningful. Even if we were able to measure Corporate Governance and Access to Finance, identifying a causal relationship going from the first to the second variable is a complex task. First, the nexus between them is riddled with endogeneity problems and it is necessary to control for other factors different from Corporate Governance which could influence Access to Finance. Second, finding an econometric relationship does not mean causality 22. A specific questionnaire on Corporate Governance practices was distributed to all WSBI members together with the WSBI annual questionnaire on Access to Finance and financial data. These questionnaires, the data used in the literature and the statistical evidence collected in previous studies by WSBI members have been used to develop specific indicators intended to provide an accurate picture of both variables. 22 Econometrically speaking the proper control variables avoiding colinearity problems should be included in the regression and afterwards, an evaluation of the existence of a causal relationship between the two should be performed using tests such as the Granger Causality Test. 75

76 Only 27 members established in 21 countries 23 answered the Corporate Governance questionnaire; and complete information on Access to Finance was provided by 25 WSBI members. Furthermore, data on both Corporate Governance and Access to Finance for the same institution were available for only nine members: Chile, Colombia, El Salvador, France, Indonesia, Peru, Philippines, Thailand and Uganda. The following table summarizes a description on the type of information provided by WSBI members. A more extensive data set would have allowed performing a more elaborated analysis on the link between Corporate Governance and Access to Finance. Table 9. Summary of WSBI members' response rates No. Answers to CORPORATE No. Answers to GOVERNANCE ACCESS TO FINANCE Observations on Questionnaire Questionnaire CG & (full) A2F Savings Loans 21 countries 23% countries 52% 25 countries 37% 9 countries 10% (27 members) (25%) 25 (54 members) (49%) (28 members) (37%) (9 members) (8%) - Developing: 17 24% - Developing: 36 51% - Developing: 17 35% - Developing: 8 11% - Industrial: 4 19% - Industrial: 12 57% - Industrial: 8 42% - Industrial: 1 5% In the absence of a more elaborated econometric exercise, a descriptive statistic analysis has been realised. In addition to the questionnaires, other sources of information were used to better understand crucial national variables such as the regulatory environment and the degree of financial development that can influence Corporate Governance and Access to Finance both at the country and at the institution level. Several alternatives have been used since, as stated before, there is no global and widely agreed measure of either Corporate Governance or Access to Finance. This section distinguishes between the country level (section 5.1.), and the WSBI members level (section 5.2.) 23 WSBI members from the following countries replied to the questionnaire: Austria, Brazil, Chile, Colombia, El Salvador, France, Indonesia, Kenya, South Korea, Lesotho, Macau, Peru, Philippines, Spain, Sweden, Tanzania, Thailand, Togo, Uganda, and Vietnam. 24 Percentage over total countries with WSBI member(s). 25 Percentage over total WSBI member institutions. 76

77 5.1. Corporate Governance and Access to Finance at country level This first analysis compares the relationship between the Honohan Index (Honohan, 2007) our chosen measure of Access to Finance at the country level and a Corporate Governance Index of our own elaboration for the specific country. This allows us to obtain a first estimate of whether the basic relationship between both variables is supported by evidence. If there were no evidence at the country level it would be much more difficult to expect a link at the level of each institution. Honohan s Index is a country-level index, developed in the 2007 paper Cross-Country Variation in Household Access to Financial Services. Honohan estimated the fraction of adult population using formal financial intermediaries by combining supply-side information on banking and microfinance institutions (from CGAP and WSBI data) with a number of demand-side estimates on the use of financial services obtained from household surveys (such as the Eurobarometer or the Finscope surveys in Africa 26 ). For WSBI member countries, the Honohan index ranks from 0.05 (Tanzania) to 0.99 (Denmark, Finland, and Sweden). To estimate a country-level Corporate Governance Index, five individual country level indicators, based on variables from other studies, were combined to create a single indicator which tries to capture the quality of the Corporate Governance in a country. This Country Index is measured through a combination of indicators including the strength of legal rights, the depth of credit information and the level of financial development and has been constructed according to the following formula: Where: n SLR: Strength of legal rights index, obtained from Doing Business, 2009, World Bank, measures the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate financial development. The index ranges from 0 to 1, with higher scores indicating that collateral and bankruptcy laws are better designed to expand access to credit. 26 See Annex 4 for the country results of the Honohan Index. 77

78 n n DCI (Depth of credit information index) PRC (Public registry coverage) and PBC (Private bureau coverage), obtained from Doing business, 2009, World Bank, measure the scope, accessibility and quality of the credit information available through either public or private credit registries. PRC reports the number of individuals and firms listed in a public credit registry and the indicator PBC does the same in a private credit bureau. The three indicators are normalized to range between 0 and 1. FD (Financial Development), obtained from the Financial Development Report, 2009, World Economic Forum, ranks 55 countries according to the level of their financial development, analysing the drivers of financial system development that support economic growth. The CGI ranges between 0 and 1. The higher the indicator, the greater the quality of the Corporate Governance at the country level. Chart 4 shows the positive and significant correlation between Corporate Governance and Access to Finance at the country level (our Corporate Governance Country Index and the Honohan index). In this sense, countries with better standards of Corporate Governance tend to have higher levels of Access to Finance. In statistical terms, and in the absence of a more sophisticated econometric analysis, almost one quarter of the variation in the level of Access to Finance at the country level would be explained by the Corporate Governance system in that country. In Chart 5, for those countries for which we have information, we plot the size of the dots according to the market share of WSBI members. The results show that in those countries with higher levels of both Corporate Governance and Access to Finance, WSBI members market share is bigger. This suggests that in countries with a better Corporate Governance environment and a relatively higher presence of institutions with an Access to Finance mission (like WSBI members) financial outreach tends to be higher. 78

79 Chart 4. Corporate Governance and Access to Finance (country level) Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Corporate Governance index at the country level and Access to Finance. Chart 5. Corporate Governance and Access to Finance with market share (country level) Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Corporate Governance index at the country level and Access to Finance. 79

80 5.2. Corporate Governance and Access to Finance at WSBI member level To evaluate the existence of a link between Corporate Governance and Access to Finance for WSBI members, we analyzed the relationship between several specific indicators of Access to Finance for these institutions (instead of the country-level Honohan index) and assess their correlation with a Corporate Governance index which incorporates institution-specific components. We have considered the standard indicators of Access to Finance, as explained in section 4: i) average deposit size 27 (the lower this indicator, the higher the outreach), ii) average loan size (the same logic as in the previous case), and iii) number of deposits per adults (the higher the indicator, the higher the outreach). For the Corporate Governance Index we have constructed a synthetic indicator which combines the countrywide Corporate Governance index explained in the previous section and an institution-specific component. Nevertheless, we should always bear in mind that the contribution of a given WSBI member to Access to Finance in its country depends inter alia on its relative size in the local banking system. Our synthetic Corporate Governance Index (CGI) has been constructed by multiplying the country level Corporate Government index by the specific index of the WSBI member institution. The rationale, as explained in chapter 3 and consistently with the empirical literature presented in Annex 1, is that the Corporate Governance environment impacts the institution. In other words, a fairly good Corporate Governance for an individual institution could be seriously undermined by a weak legal and institutional environment (and conversely, a poor Corporate Governance in a given institution could be enhanced by sound country-level practices, rules and regulation). 27 The average deposit size has been standardized among countries by their respective GDP per capita. It is equal to the average deposit size (in Euro) reported by the WSBI member, divided by the WSBI member country s GDP per capita. It ranges between 0 and 1.2 for this particular sample (a value of one implies that that the average deposit of that particular institution equals the GDP per capita of the country in which it is located). 80

81 Specifically, the index is obtained as follows: where the Specific CGI is the average of six variables: and BC (Board composition): measures the diversity in the composition of the board of directors, differentiating between members appointed by the authorities, shareholders, depositors and other stakeholders. The greater the diversity in the appointment, the higher the value of the index, which ranges from 0 to 1, as can be seen in Annex 5. CC (CEO-Chairperson): takes the value 1 if the CEO and the chairperson are not the same person and 0 otherwise, following the literature on best CG practices. POW (Proportion of women): measures the proportion of women on the board of directors, with higher values indicating more presence of women. Values range from 0 to 1. AUD (Audit) RAT (Rating) IC (Internal Code): indicates whether the institution has (i) an external audit, (ii) a rating from an agency and (iii) it has to follow an internal Corporate Governance Code. The overall score is 1 (high compliance) if the entity complies with the three requirements, 0.67 (medium compliance) if it complies with two of them and 0.33 (low compliance) if it only complies with one of them. RQ (Regulatory quality): based on the Regulatory Quality Index, one of the six World Bank s World Wide Governance Indicators for the period , which is a measure of the market-friendly environment, flexibility and the adequacy of banking supervision, as well as a perception of the burdens imposed by regulation in areas such as foreign trade and business development. In the literature the quality of financial regulation is often seen as an ingredient of the institution s Corporate Governance. For this reason we decided to include it in the specific Corporate Governance index. MIS (Mission): indicates the importance of having Access to Finance objectives in the mission statement of the institution. This component was constructed by the consultant team based on public information available at WSBI members websites. 81

82 Corporate Governance and Average Deposit Size When considering the Average Deposit Size as a measure of Access to Finance we would expect a negative relationship between the two variables. As can be seen in Chart 6 below, we find indeed a negative relationship between both variables in the case of developing countries. For industrial countries the correlation is less clear and, in any case, the small number of observations would seriously question the reliability of any such correlation. The rationale for the observed correlation, in the case of developing countries, has to do with the fact that as the quality of the Corporate Governance practices of financial institutions with a specific mandate for promoting Access to Finance improves, these financial institutions outreach also increases, which in turn is reflected in a lower average deposit. Chart 6. Corporate Governance and Access to Finance measured as average deposit size Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Overall Corporate Governance index at the country level and Access to Finance. 82

83 Since the overall Corporate Governance index includes a country component and a specific one, it is interesting to observe the isolated influence of the specific component on this Access to Finance measure. The impact of the country component on the average deposit size is also negative and the relationship between Corporate Governance and average deposit size including the country component is steeper than when only the specific one is considered. This means that the country Corporate Governance has a positive contribution to Access to Finance. Nevertheless, in this relationship, the specific component is the main responsible for the link between Corporate Governance and Access to Finance. Chart 7. Corporate Governance and Access to Finance Specific components' effects on average deposit Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Specific Corporate Governance index and Access to Finance. Evaluating each of the elements considered in the specific Corporate Governance index, we observe that when the CEO and the Chairperson are different persons, the average deposit size is smaller, which reflects a higher degree of Access to Finance (Chart 8.1). Moreover, compliance with the audit and rating agencies, or the existence of an internal Corporate Governance Code lead to lower average deposits, as can be seen in Chart

84 Chart 8. Specific Corporate Governance Components and Access to Finance (i) Separation of CEO/Chairperson and average deposits Audit/Rating/Internal Code and average deposits Source: Own elaboration. Afi, Analistas Financieros Internacionales. Chart 9.1 shows that the average deposit size is also negatively correlated with the score in the World Bank Regulatory Quality index. This suggests that market friendly policies or the adequacy of banking supervision, as well as the perception of a low burden of regulation in areas such as foreign trade and business development, tend to increase financial access. Chart 9.2 illustrates how the clarity in the Access to Finance objectives in the mission statement improves financial inclusion: having a clear objective of improving Access to Finance is negatively correlated with the average deposit size. On the other hand, the elements of the Country-level Corporate Governance index do not seem in general to be a relevant factor when observing the different levels of Access to Finance as measured by deposit size. Charts 10.1 and 10.2 show the country Corporate Governance index components that most contribute to achieving the negative relation between Corporate Governance and average deposit size. These components are: (i) the combined indicator of depth of credit information, coverage of public credit registries and private credit bureaus, and (ii) the Financial Development indicator. 84

85 Chart 9. Specific Corporate Governance Components and Access to Finance (ii) Regulatory quality and average deposit 28 Clarity of mission and average deposit Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the (i) regulatory quality index, (ii) the institutional mission and the average deposit size. Chart 10. Country Corporate Governance components and Access to Finance Credit registry coverage and average deposit Financial development and average deposit Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the (i) quality of credit information, (ii) the country s financial development and Access to Finance, measured as the average deposit size. 28 For a definition of average deposit, see footnote No

86 Corporate Governance and Average Loan Size As with deposit size, a lower average loan is usually interpreted as an indicator of a higher share of credit granted to lower income households or micro and small enterprises, as compared to bigger companies and better-off individuals. Therefore, this can also be considered as a measure of Access to Finance. As in the case of the average deposit, we can appreciate in Chart 11 that there is a negative correlation between the average loan size and the overall Corporate Governance index. Also, similarly to the previously analyzed case of deposits, this correlation is clearer in the case of developing countries. For industrial countries, despite the fact that the correlation is even stronger than in the case of deposits, the small size of the sample seriously undermines the reliability of any interpretation. This finding strengthens the results obtained in the previous section since it seems that better Corporate Governance is related to Access to Finance not only in the liabilities side but also in the assets side of the balance sheet. Chart 11. Overall Corporate Governance and Access to Finance - average loan size 29 Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Overall Corporate Governance index and Access to Finance measured as the average loan size. 29 The average loan size has been standardized among countries by their respective GDP per capita. It is equal to the average loan size reported by the WSBI member, divided by the WSBI member country s GDP per capita. 86

87 In this case, the country component is totally responsible for the negative correlation since the sign of the correlation between the specific component and the average loan size is positive (see Charts 12.1 and 12.2). It is not intuitive why the country Corporate Governance index presents the expected sign whereas the specific Corporate Governance index presents the opposite sign. Since these results are based on a very small sample of WSBI members and this negative relationship can be explained by just two observations, we do not attach much reliability to these results. Chart 12. Corporate Governance components and Access to Finance Specific components and average loan size Country components and average loan size Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Specific Corporate Governance index and Access to Finance measured as the average loan size. Despite the above mentioned scepticism on the interpretation of the correlations between Corporate Governance and loan size as the measure of Access to Finance, it is interesting to identify individual components of the specific Corporate Governance index which would induce a negative relationship with the average size of the loans: (i) the existence of an external audit, a rating from an agency and/or an internal Corporate Governance Code and (ii) the Regulatory Quality index. It is reassuring to find that these are the very same components which generated the bulk of the negative correlation in the case of the average deposit indicator, which points to a certain robustness of the results. 87

88 Chart 13. Corporate Governance components and Access to Finance (average loan size) Audit/Rating/Corporate Governance Code Regulatory Quality Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Regulatory Quality index and Access to Finance measured as the average loan size. On the other hand, the country Corporate Governance index component, which contributed the most to the slight negative correlation, is basically related to the impact of the depth and coverage of the credit information available through either public or private credit registries. Nevertheless, this is a very weak relationship as can be seen in Chart 14. Chart 14. Corporate Governance components and Access to Finance (average loan size): Credit Information Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Quality of Credit Information and Access to Finance measured as the average loan size. 88

89 Corporate Governance and Number of Deposits (corrected by adult population) The third dimension of Access to Finance we have considered is the number of deposits per 1,000 adults (potential clients), which is a traditional measure of financial outreach. To the extent that Corporate Governance fosters financial inclusion, one would expect a positive correlation between these two variables. The available data for the case of WSBI members confirm the expected correlation in the case of developing countries. Nevertheless, as with the average loan size, the explanatory power of this variable is relatively small (5.7 percent) and the small number of observations makes these results not very reliable. Chart 15. Overall Corporate Governance and Access to Finance deposits per 1,000 adults Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Overall Corporate Governance Index and Access to Finance measured as deposits per 1,000 adults. 89

90 Chart 16. Corporate Governance Index and Number of Deposits per 1,000 adults Specific components Country components Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Corporate Governance Index (both Specific and at the Country level) and Access to Finance measured as deposits per 1,000 adults. As can be seen in Chart 16, although the specific component of the index has the expected sign, the country component has the opposite sign, which is difficult to interpret. The individual components of the specific Corporate Governance index that contribute most to strengthening the relationship with Access to Finance are (i) the presence of women in the Board of Directors, and (ii) the separation between the Chairperson and the CEO, as shown in the following charts. 90

91 Chart 17. Corporate Governance Index and Number of Deposits per 1,000 adults - Proportion of women in the Board Source: Own elaboration. Afi, Analistas Financieros Internacionales. The tendency line helps to visualise the correlation between the Proportion of women and Access to Finance measured as deposits per 1,000 adults. Chart 18. Corporate Governance Index and Number of Deposits per 1,000 adults - Separation of CEO/Chairman Source: Own elaboration. Afi, Analistas Financieros Internacionales. At the country level, the components that contribute the most to promote Access to Finance are the indicator on the depth of credit information and the financial development index. 91