INSIGHTS INTO THE CORPORATE GOVERNANCE OF PHILIPPINE RURAL BANKS

Number of Rural Banks Placed Under Liquidation or Receivership (1970-June 2007) Jun 2007Total

“It is a sad and disturbing reality that at the root of most bank failure cases we have encountered, the failure of board oversight in the face of insider abuse has been a recurring theme.” Rafael B. Buenaventura, Governor, Central Bank of the Philippines The Corporate Governance of Banks: Practical Measures to Strengthen Board of Directors The Guildhall, London, 13 May 2004

CORPORATE GOVERNANCE “A set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure to which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” Organization for Economic Cooperation and Development (2004)

CORPORATE GOVERNANCE OF BANKS 1.Banks are the dominant sources of external finance in several countries; 2. Banks are generally more opaque than non-financial firms (Levine, 2003); 3.Banks are frequently heavily regulated (Levine, 2003);

CORPORATE GOVERNANCE OF BANKS 4.Banks tend to have very little equity relative to debt (Macey and O’Hara, 2003); 5.Banks’ liabilities are largely in the form of deposits while their assets take the form of loans which have longer maturities (Macey and O’Hara, 2003); 6.In an environment where there is deposit insurance, moral hazard can arise.

EXTERNAL INFLUENCES ON PHILIPPINE CORPORATE GOVERNANCE 1.On the role of the Board (BSP Circular No. 283) “The corporate powers of a bank shall be exercised, its business conducted and its property shall be controlled and held by its board of directors.” (BSP Circular No. 456) The Board is to constitute the following committees:

EXTERNAL INFLUENCES ON PHILIPPINE CORPORATE GOVERNANCE Audit Committee – at least two of whom shall be independent directors Corporate Governance Committee – at least two of whom shall be independent directors Risk Management Committee – at least three members of the board of directors

EXTERNAL INFLUENCES ON PHILIPPINE CORPORATE GOVERNANCE 2. On the minimum qualification of a bank director (BSP Circular 296) A bank director must have attended a special seminar for board of directors conducted or accredited by the BSP. A bank director must be fit and proper for the position. A minimum of two independent directors should be present at the board.

EXTERNAL INFLUENCES ON PHILIPPINE CORPORATE GOVERNANCE An LBP representative who meets the qualifications of a Director, can be an independent director (BSP, 02 January 2003). 3. On disclosure and transparency (BSP Circular No. 410) Rules and regulations on the selection, appointment, reporting requirements, and delisting for external auditors. 4. Philippine Deposit Insurance Corporation (PDIC)

General Information Sheets of 400 Rural Banks Typical board size is between 5-7 (84.25%). Highest number of independent directors in any rural bank is % of the sample have 0-2 independent directors. Rural banks which combined the roles of President and Chairman of the Board accounted for 72.25% of the sample. 58.5% are family corporations, i.e. 50% or more ownership is clearly held by a single family.

Rural Banks Rehabilitation and Review Committee (1986) 137 rural banks were found to have fictitious, indirect and questionable loans (DOSRI and other loans) 146 rural banks were found to have misapplied or misappropriated bank funds 325 rural banks had past due DOSRI or DOSRI in excess of ceiling 29 rural banks had manipulated bank records and reports 37 rural banks were found guilty of non-compliance with Monetary Board directions

Rural Bank of San Miguel (RBSM) Started banking operations in 1962 and had 15 branches by year , reported a net income of PhP million 1998 reported net loss of PhP million deposits fell to almost 40% of 1997 levels Bills Payables account shot up by 2,377.48% received emergency loans from the central bank Other Loans, 72.94% of total portfolio

Rural Bank of San Miguel (RBSM) Declared a bank holiday in 05 January 2000 Placed under receivership in 21 January 2000 PDIC, insured deposits estimated to be PhP 580 million

THE ROLE OF NON-EXECUTIVE DIRECTORS “Challenging, questioning, probing, discussing, testing, informing, debating, exploring, encouraging” Engaged but non-executive Challenging but supportive Independent but involved