Financial Sector, Business Community & Governance

1. Financial Sector, Business Community & Governance Dr. Fouad Shaker Secretary General, UAB

2. The World Strives to Achieve Economic & Social Progress • Yet… • The Record of Development Has Not Been Fully Satisfactory: • Sound Macroeconomic Fundamentals Are No Longer Enough to Prevent Crises • The World Needs A Better System • …. Better Governance • The Private Sector may be an important part of the corporate governance framework, if its own corporate governance is good; and • banks can play a detrimental role in enforcing good governance in the private sector, mainly via their financing role.

3. What is “good corporate governance”? • Narrowly defined, it is the system by which businesses are directed and by which controls are implemented • At the end of the day, it is the ‘four eyes” principle in practice • Accountability plays a key role in good governance • Transparency is needed so accountability can be monitored • Governance is often defined to cover ethical standards as defense against corruption and financial abuse • The need to strengthen governance is being acknowledged by parliaments and supervisors following the international economic and banking crises, and US corporate scandals.

4. What can good corporate governance achieve? • it protects shareholders, employees, customers, and the public • Conversely, bad corporate governance in institutions (financial and non-financial) can undermine economic and financial stability • Bad governance poses a significant reputation risk for individual firms and even for countries • If a system fails to provide incentives for good governance and does not punish transgressors, corruption flourishes • Firms which practice good governance will (a) earn higher ratings, (b) have access to cheaper funding • But trade-off needed – important not to strangle enterprise.

5. Weak corporate governance in Banks • many banks were controlled by owner-managers and independent directors played little or no role (so no ‘four-eyes” principle) • banks were often parts of wider conglomerates, so funded other parts of the group (connected lending) and were reluctant to foreclose • banks were subject to political influence in their lending decisions and credit discipline was undermined by the legal and cultural environment • management was weak and lacked self-responsibility • Growth was seen as more important than return on capital.

6. Lessons from recent corporate scandals • Conflicts of interest abound as finance becomes more complex and as each firm offers greater variety of services • The accounting and audit process is undervalued in terms of the skills needed, the responsibility and the risks incurred • Too much latitude is given to staff whose results appear to be exceptional (that in itself is often suspicious) • More attention is needed to the damaging incentives provided by badly structured compensation packages • Sadly, no governance system can be expected on its own to prevent greedy, dishonest people from putting their personal interests ahead of the organization that pays them.

7. Private Sector and Investment Situation in the Region • Inter-Arab Investments: • Despite the increase in these investments from USD1.43 bn 1995 to USD3.7 bn in 2003, yet this level constitutes only some 0.5% of the Arab economy’s GDP. • FDI (Foreign direct investment): • Despite the doubling of this investment between 1995 and 2003, yet its level constitutes only some 0.7% of total FDI in the world and 2.8% of FDI flowing into the developing world. • The private sector remains the driving force of economic growth and development, mainly via its role in activating investments in the region.

8. MENA Region Challenges • Economic fortunes influenced by oil price. • Economic policies & structures dominated by the state. • High regional unemployment rate (15% on average mostly young, better educated). • Need to create 100 million jobs in next 20 years (twice number of current jobs). • Large demand for infrastructure in the region: investment needs estimates over 2005-2010 US$28 billion (new capital: US$15 billion; maintenance: US$13 billion) • The need for good governance on the level of the macro economy and the corporate sector.

9. MENA Potentials and Challenges • Employment creation, through growth, at core of development strategy. • Region needs to develop export markets: poor record of exports (beyond oil). • Region needs to boots investments, through improved investment climate. • Region must improve infrastructure base.

10. Need for Enabling Legal, Regulatory and Governance Environment • In MENA the critical issue is NOT availability of finance. • (US$1.5 trillion of funds outside region) • Main issue is investment climate: • Sound and effective legal/regulatory environment and good corporate governance environment that fosters investment and enforces contractual obligations.

11. Development of Investment Environment in the MENA Region • Ensuring stability in investment laws and legislations, to stimulate investor’s confidence and trust. • Unifying all investment-related institutions and entities under one specific umbrella Fostering the judicial system and enhancing its independence and authority. • Development of staff in government bodies and agencies, in a way leading to lower bureaucracy and administrative corruption. • Undertaking further economic reforms

12. Development of Investment Environment in the MENA Region • Creating appropriate forward and backward investment links • A greater role for the banking sector is needed • Capital markets need to be further developed • Inter-Arab economic exchanges and cooperation should be further enhanced. • Establishing sound and strong corporate governance rules, standards and practices in the banking sector

13. Specific, Important Ingredients of Effective good Corporate Governance based- Investment Environment • In the MENA region, there is a great need to ensure healthy, sound and effective investment environment and good governance environment. • Formulation, implementation and monitoring of an effective national strategy for investment attraction. • Foreign investment strategies need to complement domestic investment strategies. • Linking foreign investment strategies to macroeconomic policies. • Enhancement of investment environment and creating attractive investment opportunities.

14. Specific, Important Ingredients of Effective good Corporate Governance based- Investment Environment • Identification of the major motives behind investment attraction and promotion • Availability of a domestic investment map which identifies, clearly, investment projects, • Enhancement of human development, especially reforming the educational system. • Establishing an encouraging image for the host country in the mind of investors, both local and foreign. • Formulation and implementation of an effective and attractive investment incentives basket Introduction of sound corporate governance policies, practices and standards.

15. Facts about the Arab Banking Sector in 2003 • Total Assets USD780 bn (GDP of Arab economy’s is USD708bn). • Total Deposits USD478bn. • Foreign Assets USD185bn. • Shareholders’ Equity USD72bn. • Average liquidity ratio (over 60%). • Average capital adequacy (over 20%).

16. Relevant Features of MENA Banks • Large liquidity “Egypt, Kuwait, Lebanon, Libya, Morocco, Yemen… Yet: • Limited activities in term financing. • Needed in project finance (productive sector and infrastructure). • Potential for maturity transformation (enhanced asset/liability management).

17. Role of MENA Banks in Meeting Growth Challenges and Business Financing • Provide more credit to private sector firms beyond energy and property sectors • Move from collateral-based to cash flow based lending (especially for SMEs). • More syndications for project finance (productive sector and infrastructure).

18. Leading Role of Banks in Developing Credit Markets • MENA banks could join more in loan syndication to spread/diversify risk in large project finance with domestic, foreign and multilateral banks. • Banks must build partnerships with other segments of financial industry: Bond markets and institutional investors. • Corporate debt securities part of diversified portfolio of institutional investors.

19. How Can Banks Exert Better Governance on Corporations? • Banks should seek to improve the behavior of their corporate clients, thus improving their own corporate governance, and hence economic governance. • Banks should have experience in using their expertise and knowledge to control the behavior of corporations.

20. How Can Banks Exert Better Governance on Corporations?.. • Banks should play a role in improving the efficiency of investment projects and their implementation. • Banks must play a much greater role in corporate control. This influence comes from the shares they own in corporations, and also from the external financing they supply corporations in the form of debt. Debt as a controlling device is an active force in corporate governance in corporations.

21. How Can Banks Exert Better Governance on Corporations?.. • Banks should enforce sound corporate governance by securing projects to be funded. They should monitor performance and enforce lending clauses. Before granting loans, they should: • Ask for project proposals, statements of financial conditions, and resumes of senior management; • Examine the shareholding structure; and • Review the borrower’s records to establish accomplishment.

22. Role of UAB in Supporting Investment Environment and Good Governance in the MENA Region • Call on governments to enhance and develop their investment environments. • Call on the business community, both local and foreign, to seek and pursue investment opportunities in the region. • Introducing latest developments in modern banking and finance • Identifying and promoting investment opportunities in the region.

23. Role of UAB in Supporting Investment Environment and Good Governance in the MENA Region… • Introducing investment-related international standards to the region’s banking sector, mainly corporate governance. • Working together with some governments to modernize investment and financial laws and legislations. • Establishing and modernization of an electronic database for investment and financial laws for the region’s countries. • Introducing the region’s investment laws and legislations to foreign investors.

24. Role of UAB in Supporting Investment Environment and Good Governance in the MENA Region… • Encouraging financial institutions, mainly banks to finance (extending credit to) regional investment projects and even participate in these projects (equity financing). • Soft landing international corporate governance policies, strategies, standards and practices to the Arab banking and financial sector.