This document provides an overview of corporate governance in the banking and financial sector in Pakistan. It discusses: 1) The importance of corporate governance for banks to meet international standards and ensure stability. 2) Key aspects of good corporate governance including qualified boards, oversight of risk and strategy, transparency. 3) Efforts made in Pakistan to strengthen governance through regulations, training, and adoption of international best practices. 4) Ongoing challenges around skills, technology, risk management, and strengthening market discipline.

1. Corporate Governance in Bank and Financial Institution
Submitted By:
Hasnain Ali 26156
Shamraz Iqbal 16480
Muhammad Waleed Asghar 18373
Muhammad Ahmad Mustafa 24649
Submitted To:
Dr.Najam Sahar

2. Executive Summary
The banking and financial institution scenario in Pakistan is changing fast to keep pace with the
International banking practice. As a result, the banks in Pakistan have been asked to meet
specific standards such as capital adequacy norms, classification of assets and income
recognition Norms etc.
The main objective of this project is to introduce about the corporate governance and how the
corporate governance workout in the Pakistan banking and financial institution sector. This
project would also provide fundamental concepts to understand about the corporate governance
and Pakistan Banking System. The project covers emergence of the concept of corporate
governance, the manner in which it is relates with banking sector, its various issues, constituents
and how it is being implemented in the banking sector. The focuses mainly on some specific
aspects of codes of corporate governance and is application in the banking sector.
Though outcomes of good corporate governance remains same irrespective of nature of business,
type of ownership, quality of management, business/legal regulations, and political environment,
but the means to achieve this good governance differs a lot based on the factors mentioned
above. Some of the parameters that may influence corporate governance include ownership
structure, board philosophy, industry segment, and maturity of business, management process,
level of competition, international business participation, and size of the company. Lot of effort
is being put both nationally and internationally in understanding and suggesting good practices
that can improve governance of banking sector.

3. Table of Content:
1. Corporate governance meaning, definition and concept
2. Why do we require Corporate Governance in the Financial Sector?
3. What does Good Governance Involve?
4. What has been done so far in Pakistan?
5. What is the Challenges Ahead?
6. Who we can improve CG in bank and financial institution?
7. What is OECD?
8. Basel Committee on Banking Supervision (BCBS)
9. Conclusion
10. References

4. 1. Corporate Governance
“Corporate Governance is the system by which companies are directed and controlled”.
Corporate governance is the acceptance by management of the inalienable rights of shareholders
as the true owners of the corporation and of their own role as trustees on behalf of the
shareholders. It is about commitment to values, about ethical business conduct and about making
a distinction between personal and corporate funds in the management of a company.
“Corporate governance is a field in economics that investigates how to secure/motivate efficient
management of corporations by the use of incentive mechanisms, such as contracts,
organizational design and legislation. This is often limited to the question of improving financial
performance, for example, how the corporate owners can secure that the corporate managers will
deliver a competitive rate of return”,. www.encycogov.com, mathiesen [2002]. “Corporate
governance deals with the way in which supplier of finance to corporation assure themselves of
getting a return on their investment”, the journal of Finance Shleifer and vishny [1997]
“Corporate governance is the system by which business corporations are directed and controlled.
The corporate governance structure specifies the distribution of rights and responsibilities among
different participants in the corporations, such as, the board, the managers, shareholders and the
other stakeholders, spells out the rules and procedures for making decisions on corporate affairs.
By doing this, it also provides the structure through which the companies objectives are set, and
the means of attaining those objectives and monitoring performance”, OECD, April 1999.
Corporate Governance Relationships among various participants in determining the direction and
performance of a corporation. Effective management of relationships among Shareholders,
Managers,Board of directors, employees, Customers, Creditors, Suppliers, community.

5. 2. Why do we require Corporate Governance in the FinancialSector?
Corporate Governance has become critical for all entities and, therefore, the codes of Corporate
Governance or legislations are being adopted increasingly by the organized Sectors in the
developed and developing countries. However, there are some additional Reasons that are unique
to the financial sector which necessitate attention to this issue.
These are:
 The rapid changes brought about by globalization, deregulation and technological
advances are increasing the risks in banking systems.
 The failure of a bank affects not only its own stakeholders, but may have a systemic
impact on the stability of other banks. All the more reason therefore to try to ensure that
banks are properly managed.
 Private sector banks are motivated by profit maximization and their own financial stakes
are limited and relatively low and they are therefore prone to excessive risk taking with
the depositors’ money. Strong corporate governance is, therefore, required to discourage
them from following this course.
3. What does GoodGovernance Involve?
 The Board Members are qualified for their positions, have a clear understanding of their
role in corporate governance and are not subject to undue influence from management or
outside concerns
 The Board must play a leadership role in approving the objectives, strategy and business
plans of the bank, monitoring the performance of management and ensuring that the
internal control and risk management systems of the bank are effective. The strategy,
vision, missions, goals and the values should be communicated throughout the
organization.
 The Board must also make sure that the Bank conducts its affairs with integrity and in
accordance with high ethical standards. The Board is part of the system of checks and
balances that ensure that neither large shareholders nor management abuse their power
and that decisions are taken with the Bank’s best interests in mind. If the Board does not
play its full part, a vacuum in leadership will be created. This vacuum may be filled by
the shareholders becoming directly involved in running the Bank’s affairs or by the
Executive Management acting more or less in isolation. In either case, the Board of
Directors is bypassed and checks and balances are lost.
 The day-to-day running of Banks should be left in the hands of the Management but the
Board should set and enforce clear lines of responsibility and accountability throughout
the organization. The Board must also ensure that there is appropriate oversight by Senior
Management.

6.  The Directors should have fair understanding of the banking business, the nature of its
risks and its strategic direction. It should be clear that ultimate responsibility for ensuring
that risks are properly identified monitored and controlled lies in the Boardroom.
 There is considerable importance attached to having an adequate representation of non-
executive and independent directors on the Board and a clear separation of the position of
Board Chairman and Chief Executive Officer.
 Directors should ensure individually and collectively that potential conflicts of interest
are avoided or, at least, managed in ways that do not compromise the interests of the
company.
 Rigorous and independent internal and external audit arrangements are at the heart of
corporate Governance debate. The work conducted by internal and external auditors in
performing an important control function should be effectively utilized by the Board in
discharging its oversight function.
 Strong emphasis should be placed on regular, timely, comprehensive, meaningful and
reliable financial disclosures of affairs. This disclosure should specify the following
information:
 Board structure (size, membership, qualifications and committees)
 Senior management structure (responsibilities, reporting lines, qualifications and
experience)
 Basic organizational structure (line of business structure, legal entity structure)
 Information about the incentive structure of the Bank (remuneration policies,
executive compensation, bonuses, stock options)
 Nature and extent of transactions with affiliates and related parties.
4. What has been done so far in Pakistan?
 Prudential regulations defining the Responsibilities of the Board of Directors have been
issued and enforced.
 Fit and proper test for Chief Executive Officers (CEO’s), Board Members and key
Executives have been laid down. Those who do not fulfill the criteria laid down in the
test are not allowed to hold the respective office.
 Minimum Disclosure requirements (quarterly and yearly) have been prescribed for banks.
 Family representation on the Boards has been limited to 25 percent and the remaining
Directors have to be independent non-executive non-family members.
 Securities & Exchange Corporation of Pakistan (SECP) Code of Corporate Governance
has been applied to banks/DFIs (where no conflict with the State Bank of Pakistan’s
(SBP) Guidelines/Directives).
 Conflict of Rules have been explicitly laid down barring stock brokers, money changers,
etc. and all those having any potential conflict from becoming involved in the
management and oversight of banks.

7.  A Handbook on Corporate Governance for Banks/DFIs containing International Best
Practices and SBP’s Instructions on the subject has been compiled, published and
disseminated.
 A Conference on Corporate Governance for Chief Executives and Board Members of
Banks/DFIs was organized to train them.
 An Institute of Corporate Governance has been established and the SBP is among its
Founder Members.
 Corporate Governance requirements for Banks/DFIs are continually reviewed to adopt
internationally recognized best practices.
 External audit firms are screened, categorized and rated for the purpose of auditing the
financial institutions. Wherever they are found deficient, they are delisted or even black-
listed.
 The impact of these measures could be summed up as follows:
 Market players are disciplined.
 Risk Management has improved.
 Quality of Board Members and Chief Executives is taking a turn for the better.
 Ingredients of a stable banking system are taking roots.
 Self Regulation is beginning to take shape.
5. What is the Challenges Ahead?
 Induction and retention of highly skilled human resources and keeping their skills in hone
will be the number one priority for all of us – the regulators, the shareholders, the
educational institutions and the Chief Executive Officers. In this respect, those of you
who are aspiring to join the financial sector have to equip yourselves with the knowledge,
skills and attitudes required for professionalism. The difference between the successful
and not so successful graduates will lie in the acquisition for life long and continuous
learning. Those who keep up with the times and strive to improve themselves throughout
their career, through learning, will have bright and promising future. Those who become
smug and complacent and adopt short cuts may have immediate gains but will find it hard
to survive in competitive financial markets over the long run.
 The other challenge is that the banks will have to automate and reengineer their business
processes, move to E-banking and multi channel delivery modes and use technological
solutions to reduce transaction costs providing satisfaction to the customers. The record
of the banking system in adoption and diffusion of technology has been mixed so far but
greater efforts will have to be made in the future.
 Credit, market and operational risks should be identified, quantified and mitigated instead
of dealing with credit risks only as was the case under Basle I. Strong Internal Rating
Systems and Management Information Systems are essential for managing these risks.

8.  The increased transparency provided by Basle II means that clients, regulators and
investors all will have a clear understanding of the institution’s operations. Consumers
and commercial clients will benefit from more timely and accurately assessed lending
decisions leading to increased customer satisfaction and loyalty in a highly competitive
market. The fog created by best guesses has to be replaced by an objective historical track
record and reliable data on which future decisions can be made. Regulators will also have
access to stronger sets of historical data and transaction trails for detailed examination
and policy decisions. Finally, investors will reward banks that capitalize on the
advantages afforded by the Accord.
 Market discipline will have to be strengthened to make governance effective in Banks.
Credit ratings, listing on the Stock Exchanges, raising funds through capital markets are
some of the mechanisms that can fortify market discipline.
 Lower capital requirement for lending to good rated borrowers will improve the overall
Governance emphasis amongst the corporations.
 Good internal controls will be established which are essential for capital assessment
process.
6. Who we can improve CG in bank and financial institution?
 Self responsibility
 Transparent informative system and improve share holder rights
 Effective independent board members
 Adopt CSR programs
 Country laws
 Share holder rights
 Credit rating agencies
 Risk advisory firms
 Auditors
 Employees
 Depositors

9. 7. What is OECD?
The Organization for Economic Co-operation and Development (OECD) is an intergovernmental
economic organization with 36 member countries founded in 1961 to stimulate economic
progress and world trade. It is a forum of countries describing themselves as committed to
democracy and the market economy, providing a platform to compare policy experiences, seek
answers to common problems, identify good practices and coordinate domestic and international
policies of its members. Most OECD members are high-income economies with a very high
Human Development Index (HDI) and are regarded as developed countries. As of 2017, the
OECD member countries collectively comprised 62.2% of global nominal GDP (US$49.6
trillion) and 42.8% of global GDP (Int$54.2 trillion) at purchasing power parity. The OECD is an
official United Nations observer. It was developed from the Organization for European
Economic Cooperation in the year 1948. The OECD founders consist of European countries of
the OEEC plus the United States and Canada. The official OECD founders are Austria, Belgium,
Canada, Denmark, France, (West) Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the
Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, United Kingdom, and the
United States.
8. BaselCommittee on Banking Supervision (BCBS)
The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory
authorities that was established by the central bank governors of the Group of Ten countries in
1974.The committee expanded its membership in 2009 and then again in 2014. In 2019, the
BCBS has 45 members from 28 Jurisdictions, consisting of Central Banks and authorities with
responsibility of banking regulation. It provides a forum for regular cooperation on banking
supervisory matters. Its objective is to enhance understanding of key supervisory issues and
improve the quality of banking supervision worldwide. The Committee frames guidelines and
standards in different areas – some of the better known among them are the international
standards on capital adequacy, the Core Principles for Effective Banking Supervision and the
Concordat on cross-border banking supervision. The Committee's Secretariat is located at
the Bank for International Settlements (BIS) in Basel, Switzerland. The Bank for International
Settlements (BIS) hosts and supports a number of international institutions engaged in standard
setting and financial stability, one of which is BCBS. Yet like the other committees, BCBS has
its own governance arrangements, reporting lines and agendas, guided by the central
bank governors of the Group of Ten (G10) countries.

10. BaselI
Basel I is the round of deliberations by central bankers from around the world, and in 1988, the
Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of
minimum capital requirements for banks. This is also known as the 1988 Basel Accord, and was
enforced by law in the Group of Ten (G-10) countries in 1992. A new set of rules known as
Basel II was later developed with the intent to supersede the Basel I accords.
Basel I, that is, the 1988 Basel Accord, is primarily focused on credit risk and
appropriate risk-weighting of assets. Assets of banks were classified and grouped in five
categories according to credit risk, carrying risk weights of 0% (for example cash, bullion, home
country debt like Treasuries), 20% (securitizations such as mortgage-backed securities (MBS)
with the highest AAA rating), 50% (municipal revenue bonds, residential mortgages), 100% (for
example, most corporate debt), and some assets given No rating. Banks with an international
presence are required to hold capital equal to 8% of their risk-weighted assets (RWA).
The tier 1 capital ratio = tier 1 capital / all RWA
The total capital ratio = (tier 1 + tier 2 capital) / all RWA
Leverage ratio = total capital/average total assets
Banks are also required to report off-balance-sheet items such as letters of credit, unused
commitments, and derivatives. These all factor into the risk weighted assets. The report is
typically submitted to the Federal Reserve Bank as HC-R for the bank-holding company and
submitted to the Office of the Comptroller of the Currency (OCC) as RC-R for just the bank.
Basel II
The Basel II Accord was published initially in June 2004 and was intended to amend
international banking standards that controlled how much capital banks were required to hold to
guard against the financial and operational risks banks face. These regulations aimed to ensure
that the more significant the risk a bank is exposed to, the greater the amount of capital the bank
needs to hold to safeguard its solvency and overall economic stability. Basel II attempted to
accomplish this by establishing risk and capital management requirements to ensure that a bank
has adequate capital for the risk the bank exposes itself to through its lending, investment and
trading activities. One focus was to maintain sufficient consistency of regulations so to limit
competitive inequality amongst internationally active banks.
Basel II was implemented in the years prior to 2008, and was only to be implemented in early
2008 in most major economies; the financial crisis of 2007–2008 intervened before Basel II
could become fully effective. As Basel III was negotiated, the crisis was top of mind and
accordingly more stringent standards were contemplated and quickly adopted in some key
countries including in Europe and the US.
Basel II uses a "three pillars"

11. The first pillar: Minimum capital requirements
The first pillar deals with maintenance of regulatory capital calculated for three major
components of risk that a bank faces: credit risk, operational risk, and market risk. Other risks
are not considered fully quantifiable at this stage.
1. The credit risk component can be calculated in three different ways of varying degree of
sophistication, namely standardized approach, Foundation IRB, Advanced IRB and
General IB2 Restriction. IRB stands for "Internal Rating-Based Approach".
2. For operational risk, there are three different approaches – basic indicator approach or
BIA, standardized approach or TSA, and the internal measurement approach (an
advanced form of which is the advanced measurement approach or AMA).
3. For market risk the preferred approach is VaR (value at risk).
As the Basel II recommendations are phased in by the banking industry it will move from
standardized requirements to more refined and specific requirements that have been developed
for each risk category by each bank. The upside for banks that do develop their bespoke risk
measurement systems is that they will be rewarded with potentially lower risk capital
requirements. In the future, there will be closer links between the concepts of economic and
regulatory capital.
The second pillar: Supervisory review
This is a regulatory response to the first pillar, giving regulators better 'tools' over those
previously available. It also provides a framework for dealing with systemic risk, pension
risk, concentration risk, strategic risk, reputational risk, liquidity risk and legal risk, which the
accord combines under the title of residual risk. Banks can review their risk management system.
The Internal Capital Adequacy Assessment Process (ICAAP) is a result of Pillar 2 of Basel II
accords.
The third pillar: Market discipline
This pillar aims to complement the minimum capital requirements and supervisory review
process by developing a set of disclosure requirements which will allow the market participants
to gauge the capital adequacy of an institution.
Market discipline supplements regulation as sharing of information facilitates the assessment of
the bank by others, including investors, analysts, customers, other banks, and rating agencies,
which leads to good corporate governance. The aim of Pillar 3 is to allow market discipline to
operate by requiring institutions to disclose details on the scope of application, capital, risk
exposures, risk assessment processes, and the capital adequacy of the institution. It must be
consistent with how the senior management, including the board, access and manage the risks of
the institution.

12. BaselIII
Basel III is a global, voluntary regulatory framework on bank capital adequacy, stress testing,
and market liquidity risk. This third installment of the Basel Accords was developed in response
to the deficiencies in financial regulation revealed by the financial crisis of 2007–08. It is
intended to strengthen bank capital requirements by increasing bank liquidity and decreasing
bank leverage.
Basel III was agreed upon by the members of the Basel Committee on Banking Supervision in
November 2010, and was scheduled to be introduced from 2013 until 2015; however,
implementation was extended repeatedly to 31 March 2019 and then again until 1 January 2022.
The Basel III standard aims to strengthen the requirements from the Basel II standard on bank's
minimum capital ratios. In addition, it introduces requirements on liquid asset holdings and
funding stability, thereby seeking to mitigate the risk of a run on the bank.
Capital requirements
The original Basel III rule from 2010 required banks to fund themselves with 4.5% of common
equity (up from 2% in Basel II) of risk-weighted assets (RWAs). Since 2015, a minimum
Common Equity Tier 1 (CET1) ratio of 4.5% must be maintained at all times by the bank. This
ratio is calculated as follows:
The minimum Tier 1 capital increases from 4% in Basel II to 6%, applicable in 2015, over
RWAs. This 6% is composed of 4.5% of CET1, plus an extra 1.5% of Additional Tier 1 (AT1).
Furthermore, Basel III introduced two additional capital buffers:
 A mandatory "capital conservation buffer", equivalent to 2.5% of risk-weighted assets.
Considering the 4.5% CET1 capital ratio required, banks have to hold a total of 7% CET1
capital ratio, from 2019 onwards.
 A "discretionary counter-cyclical buffer", allowing national regulators to require up to an
additional 2.5% of capital during periods of high credit growth. The level of this buffer
ranges between 0% and 2.5% of RWA and must be met by CET1 capital.
Leverage ratio
Basel III introduced a minimum "leverage ratio". This is a non-risk-based leverage ratio and is
calculated by dividing Tier 1 capital by the bank's average total consolidated assets (sum of the
exposures of all assets and non-balance sheet items). The banks are expected to maintain a
leverage ratio in excess of 3% under Basel III.
In July 2013, the U.S. Federal Reserve announced that the minimum Basel III leverage ratio
would be 6% for 8 systemically important financial institution (SIFI) banks and 5% for their
insured bank holding companies.

13. Liquidity requirements
Basel III introduced two required liquidity ratios.
 The "Liquidity Coverage Ratio" was supposed to require a bank to hold sufficient high-
quality liquid assets to cover its total net cash outflows over 30 days. Mathematically it is
expressed as follows: LCR = High quality liquid assets/Total net liquidity out flow over
30 days > 100%
 The Net Stable Funding Ratio was to require the available amount of stable funding to
exceed the required amount of stable funding over a one-year period of extended stress.
9. Conclusion
Principles of Good Corporate Governance (GCG) banking sector in the form of fairness,
transparency, Accountability and responsibility has a strategic role in supporting the
implementation of the principles of risk management as prudence which must be implemented
by the bank, since the implementation of risk management required for applications of the
principles of accountability, responsibility, fairness and openness.
Governance failures are often tied to underlying market failures. Information and disclosure play
an important role in mitigating both fundamental market failures and their manifestations as
governance failures. Regulators can choose one of two approaches when attempting to increase
market discipline and information disclosure. First, they can mandate the production of
information outside of markets through increased regulatory disclosure. Second, they can
directly motivate potential producers of information by changing their incentives. If the lack of
transparency in the banking industry is a symptom rather than the primary cause of bad
governance, then policies that motivate rather than mandate information production may
therefore be more successful in governing financial institutions.
Banks are highly leveraged entities and their success/failures would have impact on the monitory
sector of the economy. The emerging corporate governance guidelines for banks would play vital
role in fulfilling broader expectation of the society. Banking sector has strong linkage with real
sector of the economy and they are a major source of funding and payment to all types of
economic activities. Banking sector has mixed ownership in the form of nationalized banks,
private sector banks, foreign banks and other financial institutions.

14. 10. References
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Basel Committee on Banking Supervision
Bank for International Settlemen tory of the Basel Committee and its Membership"
in http://www.bis.org/bcbs/history.pdf
Jump up to:a b "OCC Approves Basel II Capital Rule". occ.gov. November 2007. This final rule
is effective April 1, 2008.
Jump up to:a b "Basel II – questions and answers". cml.org.uk. Archived from the original on
2011-12-14.
"Basel III – Implementation - Financial Stability Board". www.fsb.org. Retrieved 21
March 2019.
"The Basel Committee's response to the financial crisis: report to the G20". Bis.org. 2010-10-19.