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38
ECONOMIC ANNALS-XXI
MONEY, FINANCE AND CREDIT
Lentner, Cs., Vasa, L., Kolozsi, P. P., & Zéman, Z. / Economic Annals-XXI (2019), 176(3-4), 38-48
Csaba Lentner
D.Sc. (Public Finance), Full Professor, Head of Department,
Faculty of Political Sciences and Public Administration,
Public Finance Research Institute,
National University of Public Service;
PADS Leader Economist, Central Bank of Hungary
5 Ménesi Str., Budapest, 1118, Hungary
lentner.csaba@uni-nke.hu
ORCID ID: http://orcid.org/0000-0003-2241-782X
Pál P. Kolozsi
Associate Professor, PhD (Economics),
Corvinus University of Budapest and National University of Public Service
5 Ménesi Str., Budapest, 1118, Hungary
Kolozsi.Pal.Peter@uni-nke.hu
ORCID ID: https://orcid.org/0000-0001-5713-776X
László Vasa
D.Sc. (Economics), Research Professor,
Széchenyi István University
1 Egyetem Str., Győr, H-9026, Hungary
laszlo.vasa@ifat.hu; vasa.laszlo@sze.hu
ORCID ID: https://orcid.org/0000-0002-3805-0244
Zoltán Zéman
D.Sc. (Economics), Full Professor, Head of Department,
Faculty of Economics and Social Sciences,
Business Institute,
Szent István University
1 Páter Károly Str., Gödöllő, 2100, Hungary
zeman.zoltan@gtk.szie.hu
ORCID ID: http://orcid.org/0000-0003-2504-028X
ECONOMIC ANNALS-XXI
ISSN 1728-6239 (Online)
ISSN 1728-6220 (Print)
https://doi.org/10.21003/ea
http://www.soskin.info/ea/
Volume 176 Issue (3-4)’2019
Citation information:
Lentner, Cs., Vasa, L., Kolozsi, P. P., & Zéman, Z. (2019). New dimensions of internal controls in banking after the GFC. Economic
Annals-XXI, 176(3-4), 38-48. doi: https://doi.org/10.21003/ea.V176-04
New dimensions of internal controls in banking after the GFC
Abstract
The weakness of the control function of governments and central banks was the main regulatory cause of the
global financial crisis (GFC) broke out in 2007, but the suboptimal regulatory environment «corrupted» the quality
of internal control and audit of banks as well. After the crisis, corporate governance issues appeared in the focus
of international organizations. In this paper, we present the relevant international recommendations aimed at
improvement of the weak corporate governance practices of the banking sector. Based on the comparison of
pre- and post-crisis internal control functionalities which are presented as a meta-analysis and a systematic
review of the existing empirical researches, the authors conclude that the stricter guidelines could and can have
a positive impact on banks’ operations stabilizing through the strengthening of internal control practices.
Keywords: Internal Control; Banking Sector; Global Financial Crisis; GFC; Corporate Governance; Corporate
Social Responsibility; CSR; CRM; RAR; CRD Directive; EBA; Basel Committee
JEL Classification: G21; G34; H12
Acknowledgements: This study is written as a part of support for Prof. Lentner at PADS Foundation - The
National Bank of Hungary (Magyar Nemzeti Bank).
Authors’ Contribution: Each author contributed equally to the research.
DOI: https://doi.org/10.21003/ea.V176-04
Лентер Ч.
доктор економічних наук, професор, факультет політології та державного управління, Національний
університет державної служби; провідний економіст, Національний банк Угорщини, Будапешт, Угорщина
Ваша Л.
доктор економічних наук, професор, Університет Іштвана Сечені, Дьйор, Угорщина
Коложи П.
кандидат економічних наук, доцент, Університет Корвіна;
Національний університет державної служби, Будапешт, Угорщина
Земан З.
доктор економічних наук, професор, факультет економіки та суспільних наук,
Інститут бізнесу, Університет Святого Іштвана, Гьодоло, Угорщина
© Institute of Society Transformation, 2019
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Нові виміри внутрішнього контролю в банках після глобальної фінансової кризи
Анотація. Слабкість контрольної функції урядів і центральних банків була основною регуляторною
причиною глобальної фінансової кризи (ГФК – GFC), яка вибухнула в 2007 році, але неоптимальне
регуляторне середовище також погіршило якість внутрішнього контролю й аудиту банків. Після кризи
питання корпоративного управління опинилися в центрі уваги міжнародних організацій. У цій роботі
ми представляємо відповідні міжнародні рекомендації, спрямовані на вдосконалення слабкої практики
корпоративного управління банківського сектору. На основі порівняння функцій внутрішнього
контролю до та після кризи, які представлені як метааналіз і системний огляд існуючих емпіричних
досліджень, автори роблять висновок, що більш жорсткі вказівки могли й можуть мати позитивний
вплив на діяльність банків через посилення стабілізуючої практики внутрішнього контролю.
Ключові слова: внутрішній контроль; банківський сектор; глобальна фінансова криза; корпоративне
управління; корпоративна соціальна відповідальність; КСВ; ЄБА.
Лентнер Ч.
доктор экономических наук, профессор, факультет политологии и государственного управления,
Национальный университет государственной службы; ведущий экономист,
Национальный банк Венгрии, Будапешт, Венгрия
Ваша Л.
доктор экономических наук, профессор, Университет Иштвана Сечени, Дьёр, Венгрия
Коложи П.
кандидат экономических наук, доцент, Университет Корвина;
Национальный университет государственной службы, Будапешт, Венгрия
Земан З.
доктор экономических наук, профессор, факультет экономики и общественных наук,
Институт бизнеса, Университет Святого Иштвана, Гёдоло, Венгрия
Новые измерения внутреннего контроля в банках после глобального финансового кризиса
Анотация. Слабость контрольной функции правительств и центральных банков была основной
регуляторной причиной глобального финансового кризиса (ГФК – GFC), который разразился в
2007 году, но неоптимальная регуляторная среда также ухудшила качество внутреннего контроля и
аудита банков. После кризиса вопросы корпоративного управления оказались в центре внимания
международных организаций. В этой работе мы представляем соответствующие международные
рекомендации, направленные на совершенствование слабой практики корпоративного управления
банковского сектора. На основе сравнения функций внутреннего контроля до и после кризиса,
которые представлены как метаанализ и системный обзор существующих эмпирических исследований,
авторы делают вывод, что более жесткие указания могли и могут иметь положительное влияние на
деятельность банков усиливая стабилизирующие практики внутреннего контроля.
Ключевые слова: внутренний контроль; банковский сектор; глобальный финансовый кризис;
корпоративное управление; корпоративная социальная ответственность; КСО; ЕБА.
1. Introduction
The global financial crisis erupted in 2007-2008 at the Anglo-Saxon mortgage markets, due to
the globalised nature of the financial world, escalated into a global level (F. Bruni and D. T. Llewellyn
2009; Financial Crisis Inquiry Commission, 2011). There were a large number of factors underpin-
ning the crisis, and consequences were also very complex, the most prominent of which was a de-
crease in the consumption of households within a general decline in the economy (Acharya & Ri-
chardson, 2009). Even if the economic downturn of 2007-2009 diered considerably from the for-
mer recessions, various key indicators (consumption, output, investment, labour market structure)
projected, although not completely clearly, an expectable crisis. The market, however, failed to re-
spond to these signs adequately (Ohanian, 2010; Ocampo, 2009).
History demonstrates that capitalist regimes undergo crises regularly but periodically
(Uryszek, 2015). The most frequent crisis is the «bubble», and not necessarily its emergence but
its «deflation» means the occurrence of a crisis (Kotz, 2009; Carmassi, Gros, & Stefano, 2009).
The institutional form of capitalism and the social structure of accumulation promote high pro-
fits and econo mic expansion for a while, but eventually the contradictions - as a result of that
form of capitalism- undermine its continuing operation, leading to a systemic crisis.
The crisis which started in the Anglo-Saxon mortgage markets diers considerably from the cri-
sis of 1929-1933, with which many parallels have been drawn. While the main root cause of the
latter crisis was essentially linked to the monetary policy, that of the crisis escalated by 2008 was
rather over-lending and over-borrowing, providing mostly insolvent citizens with housing loans. The
crisis starting from lending anomalies gives rise to a considerable extent to the responsibility of, in
addition to regulatory and supervisory authorities and the households superficially assessing their
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loan repayment abilities, banks, since they failed to act with due diligence in the period prior to len-
ding and during loan monitoring activities (Zwolankowski, 2011).
The operation of internal controlling systems of banks and dierent monitoring and internal regu-
latory systems, as well as their operational eciency and their continuous assessment are extreme-
ly important not only for banks but the entire economy. These controlling systems must also focus
on measuring disequilibrium in credit and capital markets (Besanko & Kanatas, 2015).
This paper is focused on internal controls of banks. The structure of the paper is the following.
After a brief literature review we define the purpose of the analysis, and then we present the results
of the research, especially concerning the shortcomings of internal controls during the pre-crisis
period, the changes in bank controlling methodology after the crisis and the recommendations of
international organisations concerning corporate governance. The last chapter concludes and gives
perspectives to further research.
2. Brief Literature Review
Internal controls of banks represent the eort to achieve a synergy of profitability, growth and
risk-taking factors, beside optimal profitability and limited risk-taking (Andersen, 1986). Controlling
is a philosophy and a mindset which may extend onto decentralised managerial areas through in-
formation management, therefore internal controls may become a management information centre.
The deviation of bank controlling from standard controlling methodology is determined by the indi-
vidual and complex tasks of banks’ value creation processes and their products as well as by the
banking transactions (payment transactions, lending, capital investment etc.). It is therefore clear
that bank controlling, in view of its nature, performs management tasks for the bank as a whole
by integrating two well-defined partial areas, i.e. the controlling tasks of the bank’s internal opera-
tion and the services. This integration can only be achieved by connecting controlling subsystems
functioning within the bank’s organisation, i.e. cost controlling, profit controlling, financial control-
ling, planning, plan-fact deviation analysis and information provision functions. Consequently, the
orien tation of bank controlling is twofold. One comprises all the controlling tasks that guarantee the
bank’s internal operational security, and the other consists of customer controlling tasks between
the bank and its clientele (Kalmár, Zéman, & Lukács, 2015).
Eciently and properly functioning internal controls are one of the most important means of
ensuring compliance with the accounting principle of the bank’s operation. Within the corpora-
tions, more and more emphasis is put on internal performance pressure, since market and other
opportunities for additional funding have become uncertain amidst the crisis and budgetary bot-
tlenecks. In relation to bank controlling, several regulations must be mentioned which aect the
operation of internal controls. Since commercial banks operate in the form of profit-oriented firms,
they must comply with the changes in various accounting principles. In an internationally exten-
ded global competition, one of the fundamental key factors of the long-term viability of compa-
nies is their competitiveness. According to a theoretical approach, this means the prevalence of
the going concern basis of accounting, with which these organisations also contribute to eco-
nomic expansion, because long-term viability is an initial condition. The continuous development
of intra-company controlling mechanisms allows companies to maintain continuous changes in
the set of criteria and to adapt to changes (essentially with the appearance of the International
Financial Reporting Standards).
Credit institutions and banks operate in a stringent regulatory environment. The regulation per-
sisting after the economic crisis is largely dierent from that of a balanced financial and economic
era. Since public confidence in financial institutions and markets started to decrease rapidly after
2007, policy-makers had to review their role played in the global economic turmoil. In response to
the financial crisis emerging in 2007-2008, extensive legislative initiatives were undertaken in many
jurisdictions, most notably in the US and the EU, as well as on international level. This was often
accompanied by a revamping of existing institutions, such as the Basel Committee on Banking Su-
pervision (BCBS), or the introduction of new organisations, such as the Financial Stability Board
(Chatzistavrou, Katsikas, & Tirkides, 2013; Lentner, 2016).
3. Purpose
The purpose of the paper is to examine the main pillars of the internal control and audit sys-
tems of banks, the evolution of regulatory methods and to present the relevant international recom-
mendations, whose main objective is to correct the weak or, in many cases, superficial corporate
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governance practices of the banking sector. Our paper also presents a meta-analysis and a sys-
tematic review of the relevant researches on how internal control practices are realized, executed in
banks. Our study is focused on the general framework, the main pillars of the internal control sys-
tem of banks, which means that we do evaluate essentially the general trends instead of the prac-
tice of individual banks.
4. Results
Shortcomings of external and internal controls during the pre-crisis period
The task of the banking sector is, in addition to reducing costs and allocating capital, to ma-
nage economic risks in some way, and ensure the stability of the economy with this risk ma-
nagement. One of the visible signs of the global economic crisis was the fact that banks sus-
tained enormous losses, which could be regarded as the spill-over of the crisis of the real eco-
nomy, but ultimately it was about financial enterprises which did not adequately lent the money
entrusted to them, that is they failed to complete their risk management tasks properly or assess
repayment risks correctly. This kind of profit-oriented mindset contributed to the collapse of the
global economy. Excessive lending, countries ending up in the debt trap, corporate indebted-
ness and over-lending of households exceeding their creditworthiness are interrelated and con-
sequential phenomena.
Before the crisis, low levels of financial literacy on the consumers’ side, and the increased com-
plexity of financial products on the financial services providers’ side led to many consumers feeling
that they had been abused or misled, which was actually the case in many instances. Apart from
that, the activity of unregulated or inadequately controlled financial service providers considering
short-term economic performance only increased the risk that borrowers became victims of abuse
or fraud (OECD, 2011).
Indebtedness is a particularly severe socio-economic problem. In addition to a continuous in-
crease of government debt, the shortfall of primary revenues and income not covering the spen-
ding of local authorities, and households in particular, appears. In order to bridge this gap, inten-
sive bank lending and then, due to missed payments, continuous and permanent indebtedness ap-
pears. The direct causes of the global economic crisis were the deficiencies of mortgage regula-
tions and their security procedures and the malfunctions and the deregulation of over-the-counter
derivatives transactions and the shadow banking system. Non-interventionism appears on a sys-
temic level in the operation of governments and supervisory authorities pursuing neo-liberal ideas.
Regulation before the crisis did not ensure the fundamental principles guaranteeing the securi-
ty and stability of the financial system which would have been required for avoiding the crisis. Fi-
nancial regulation should have been targeted, rule-based, and dynamic. The globalisation of finan-
cial markets manifested itself in an increasing degree and a higher level of interconnectedness and
similarity of financial institutions. As a result, the implementation of a universally applicable financial
regulation became more dicult, and it still is.
In the homeland of the global financial crisis, the U.S., the rapid expansion of subprime and
Alt-A loans primarily concentrated around the period from 2004 to 2006. This is clearly demonstra-
ted by the fact that the combined share of subprime and Alt-A loans in newly issued loans increased
to 40 per cent in 2006 from 10 per cent in 2003. In this period, due to a continuous rise of real es-
tate prices in the U.S., such borrowers could take out loans that were risky in terms of income or re-
payment terms and conditions. Both borrowers and lenders were confident that capital gains made
by a further increase in real estate prices would ensure repayment. As interest rates had been in-
creasing continuously after the end of 2003, it became increasingly dicult for a group of subprime
borrowers to take out loans, therefore lenders gradually started to relax loan terms and conditions.
Due to less stringent standards, people obtained more and more loans, with an own contribution
of less than 10 per cent, without an appropriate income certificate, and, in the initial phase, within
the framework of loan profiles providing a low repayment burden and negative amortisation. This is
excellently illustrated by the example that the share of variable-rate mortgage loans, ensuring a low
interest rate for two years in general, had reached 50 per cent in the subprime category by 2006
(Nagy & Szabó, 2008). The volume of these high-risk loans should have been curbed by the control
functions of financial institutions. This did not happen or just to a very small extent, since the appe-
tite for profit and the short-term thinking of these institutions overrode the very high future risks an-
ticipated by control functions.
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Changes in bank controlling after the GFC
Following the global financial crisis, financial management controls and internal controls have
become more valuable, because of the growing non-performing loan portfolios, on the one hand,
and the worsening of the general macroeconomic environment, on the other hand. For that reason
the previously used control methodology and the importance of system components have changed
since the crisis (CIMA, 2016; Lintner & Lincoln, 2016; Malmi & Brown, 2008).
An important element of the change was that before the crisis the focus was essentially on short
and medium term planning, which was replaced and completed by long term planning and an in-
creasing focus on capital management planning. Concerning financial control, budget planning
used to be linked to 12-month period, using traditional budgeting methods with a financial Key Per-
formance Indicator (KPI) measure set. New budgeting methodologies (Beyond Budgeting) had been
adapted, with 1-3 years budgeting practice, and an increased focus on ROE, liquidity, capital ra-
tios and cost/profit measures.
Before the crisis, the main focus was put on governance and organization structure, policies
and procedures, while after the GFC, administrative control was extended to comprehensive risk
controls, governance and compliance management as well, with improved internal audit proces-
ses. Concerning the issues of corporate culture, the main function was the identification of funda-
mental values on which banks operate, but after the crisis that was extended to support embed-
ding of va lues in the organization through hiring practices, social events and mentoring programs
for mana gers and employees. In course of this, the design and control of reward and compensation
schemes, especially concerning the remuneration of top-managers causing moral hazard problems
in the past, was modified. In information management, the main focus moved from internal repor-
ting with information collecting functions to internal and external reporting with central information
distribution functions, with new tools such as data warehouses and integrated information systems.
(CIMA, 2016; Lintner & Lincoln, 2016; Zeman, Kalmar & Lentner, 2018).
International bank consolidation is an increasingly complex response given to the global fi-
nancial crisis. During this consolidation, the micro-procedural and macro-procedural regulation
of banks should be highlighted, and the role of various control systems have also acquired a new
significance (M. Kowalik, T. Davig, Ch. S. Morris, and K. Regehr (2015) - US banking; The Bank of
Spain (2017) - Spanish banking; M. S. Mohanty (2014) - pan-African banking).
The development of currently operating control systems lie in mapping and integrating the pro-
cedures applied during banking activities. The development of information technology makes it
possible to run complex algorithms on extensive databases, which, in addition to a number of other
benefits, facilitates more accurate forecasting, income and cost planning as well as more reaso-
nable cost management. The various risk assessment («scoring») models, which focus on the risks
of customers becoming insolvent, are worth highlighting. Although the primary objective of these
methods is related to the given banking function, both the methodology and the results may im-
prove the planning and analysis functions of the management controlling system via more accurate
forecasting; in addition, they contribute to banks’ more ecient cost management.
In that context it is also important to focus on CSR and its changes after bank consolidation pro-
cesses. CSR means a combination of behaviours and ideas which conveys and asserts environ-
mental, social and human interests and value beyond internal corporate viewpoints in relation to
sustainable development (the fundamental principle of a going concern in accounting) and business
ethics. It includes the transparency of the given organisation, its compliance with ethical norms, and
an as extensive as possible consideration of viewpoints of those seeking information inside or out-
side the company in connection with it.
A bank’s CSR activity may have several focal points. It may focus on internal and external stake-
holders, may be directly related to the bank’s activity or it may be independent from both. Providing
financial and banking information adjusted to the knowledge level of customers taking out loans is
a CSR activity directly related to the banking activity, which may reduce the rate of bad debt, and,
at the same time, creates some stability in the customers’ financial management. It matters who is
in the focus of the bank’s CSR activity, but it is also important how much weight the given activity
has in the life of the bank and the stakeholders.
Beyond the classical stakeholder models, the CSR of the banking sector manifests also in a
practical form of refraining from causing market disturbances by presenting a fictitious econo mic
situation, so that funds should not be redeployed from public reserves to consolidate financial
institutions. The financial crisis requires the definition of a new type of CSR assumed by banking
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companies and financial institutions, in addition to traditional corporate social responsibility. In
addition to traditional CSR approaches, the financial institutions’ responsibility for customers,
enterprises, families and national budgets is becoming increasingly important. A great empha-
sis should be placed on morals by financial institutions. From the viewpoint of economics and fi-
nance, banks operating without a solid moral foundation, pose a hazard to the economy and so-
ciety (Sh. C. Dow, 2010). To sum it up, banks as the main institutions ensuring the stability of the
national economy and the international financial sector can do their best in terms of corporate
social responsibility with calculable operations, the application of crediting techniques to retain
their customers in the long term and conveying financial knowledge. Thus, the partial responsi-
bility-taking dimension of the banking sector focussing on sub-parts is replaced by taking com-
plex responsibility for the social, the national economic and even the global economic space si-
multaneously (Lentner, Szegedi & Tatay, 2015). In respect of risk management and responsibili-
ty-taking, the corporate sector is of major importance; in particular, attention should be focussed
on changing the practices of lending to small and medium-sized enterprises. Internal controls
and scoring systems have changed also in this sector after the global economic crisis (Belás,
Dvorsky, Kubálek & Smreka, 2018).
The changes in and the alteration of the principles of internal controls were one of the most im-
portant and most eective tools during consolidation after the crisis. During the consolidation, fi-
nancial institutions changed the approach of their lending business, partly by themselves, partly
under external pressure. In the background of this shift, there is a significant transformation in the
European and the U.S. banking sector. The development of risk assessment methodologies and
tools, and the regulatory systems established in the consolidation period of the crisis, to which va-
rious structural changes connected, made financial institutions pay growing attention to assessing
and managing their credit risks, and the capital adequacy ratio related to these risks. Having taken
these developments into consideration, and within the framework of bank consolidation, the Basel
Committee on Banking Supervision revised the framework system that constitutes the fundamen-
tals of the regulation pertaining to banks’ capital adequacy. Summing up the events of recent years,
it can be established that the Basel II regulation placed the emphasis on microprudential issues
and enhanced the procyclical nature of banking practices in several aspects. It did not manage ef-
fectively system-level macroprudential risks. Another important fact is that Basel II provided banks
with a relatively flexible system, in which they could establish on their own the nature and extent of
risks they faced, enhancing market risk factors of financial organisations. The Basel Committee on
Banking Supervision made its decision on Basel III as a set of regulations pertaining to capital re-
quirements in September 2010. The goal of this new regulation was to strengthen the micropruden-
tial level, consequently, to improve banks’ resilience to shocks or stress factors, furthermore, it in-
troduced an anticyclical buer which can be applied during crises, and also prescribes compliance
with a net stable funding ratio and a liquidity coverage ratio and contain macroprudential reforms to
manage systemic risks. It will also be decisive how particular countries will adopt and submit to the
requirements of Basel III. In the U.S. for example, an implementation of the Dodd-Frank Act, adop-
ted in 2010, is applied in the operation of financial institutions (EBIC, 2013). Stricter capital require-
ments, liquidity requirements and additional rules imposed on a systemic level on banks are likely
to make the banking system more solid in the long term.
It is important to mention the types and changes of dierent internal credit rating systems, and
their directions. Credit rating principles can be classified either on the basis of the principle of rating
to standard or on the basis of internal banking operational systems. The former one is a pre-deter-
mined weighting scoring system, while the latter is based on banks’ internal operational evaluation.
In Europe, financial institutions can use internal methods since 2007. Theoretically, internal me thods
assess risks more eectively, because, as opposed to a standard method applied by all banks in
a uniform manner, it can take many individual specifications into account. In practice, there is am-
ple proof that banks’ internal rating systems are not infallible in all cases (Treacy & Carey, 2000). As
it has been set out above, over-crediting by financial institutions and serving high-risk customers
was one of the causes of the global economic crisis arisen in 2007-2008. Various organisations with
banking regulatory rights attempt to avoid this with the help of monitoring systems and rules, so that
it should not occur in this form in the future. Banks also have a credit risk management (CRM) func-
tion, the aim of which is to minimise risks and to maximise risk-adjusted return (RAR) on the colla-
teral of credit facilities. The task of CRM is to establish the risk profile with the help of the borrower’s
assessment and scorecards (Zahra, 2017) as it is presented in Figure 1.
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After the global financial crisis the continuous control of banks has become important to make it
visible how ready they are for the next recession. Scenario analysis and stress testing are risk ma-
nagement tools that test the capability of dierent financial institutions to remain standing in the
case of another financial recession. These tests examine and analyse the banks’ capabilities and
tools to respond to a financial shock, and their overall eciency with which they would be able to
manage the arising crisis.
Corporate governance recommendations of international organisations
In the years following the crisis, corporate governance issues came also in the focus of inter-
national organizations. The main purpose was to correct the weak or, in many cases, superficial
corporate governance practices of institutions, which the global financial crisis clearly highlighted.
Even if we accept that the applicability of these guidelines and recommendations can be proble-
matic - see the feedback of banks and professional associations on the public consultation of the
EBA guidelines in European Banking Authority (2017), we can assume that these new regulations
played a significant role in determining the direction in which the internal controls and governance
system of banks developed after the GFC.
Adequate corporate governance is of crucial importance for the operation of both individual insti-
tutions and the banking system as a whole. J. I. Lee (2015) confirmed that the internal control sys-
tem and the professional experience of the employees contribute to the profitability of investments
and the level of returns in the financial sector of Korea. Through the Swedish example, Li and
Wahlstrom (2018) presented banks’ internal control and risk management systems and their impact
on bank’s operation, concluding that even if banks developed dierent systems, these frameworks
had a significant impact on the financial performance of individual banks.
After the global financial crisis, the rules of corporate governance have become more vigorous,
also in the sense that more international organisations have issued stricter directives or recommen-
dations. Without being exhaustive, the following ones can be regarded as the most important.
• CRD Directive
Within the CRD Directive 2013/36/EU, eective since 2014, primarily Articles 74 to 96 belong to
here, which focus on the issues about interval governance, recovery plans, remuneration policies,
risk management requirements, corporate governance systems and the composition of the ma-
nagement body.
Article 74 of the general principles of the directive focusses on the topic of internal governance,
as well as recovery and resolution plans. The directive lays down that institutions shall have robust
governance arrangements, which include a clear organisational structure with well-defined, trans-
parent and consistent lines of responsibility, eective processes to identify, manage, monitor and
report the risks they are or might be exposed to, adequate internal control mechanisms, including
sound administration and accounting procedures, and remuneration policies and practices that are
consistent with and promote sound and eective risk management. The arrangements, processes
and mechanisms shall be comprehensive and proportionate to the nature, scale and complexity of
the risks inherent in the business model and the institution’s activities. Article 75 focusses on the
Figure 1:
Credit Risk Assessment Funnel
Source: Zahra (2017)
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oversight of remuneration policies. Subsection 2 of the directive regulates the technical criteria con-
cerning the organisation and treatment of risks, and subsection 3 sets out the requirements on go-
vernance (including governance arrangements, the management body and remuneration policies).
• Recommendations of the Basel Committee
The Basel recommendation - called «Corporate governance principles for banks» - sets out
that eective corporate governance is critical to the proper functioning of the banking sector
and the economy. Banks perform a crucial role in national economies as funds are intermediated
from depositors to borrowers in the banking system. The proper functioning of banks is a key to
financial stability; if the corporate governance model of banks is wrong, problems occurring at
speci fic banks can be transmitted across the economy as a whole. The primary purpose of cor-
porate go vernance - which is interpreted by BIS as the allocation of tasks and responsibilities -
should be, according to BIS, safeguarding stakeholders’ interest (1) in conformity with public in-
terest and (2) on a sustainable basis. Among stakeholders, BIS highlights, particularly with re-
spect to retail banks, shareholders’ interest would be secondary to depositors’ interest.
The Basel Committee sets out 13 principles, which concern the following areas:
1. Board’s overall responsibilities.
2. Board qualifications and composition.
3. Board’s own structure and practices.
4. Senior management.
5. Governance of group structures.
6. Risk management function.
7. Risk identification, monitoring and controlling.
8. Risk communication.
9. Compliance.
10. Internal audit.
11. Compensation.
12. Disclosure and transparency.
13. The role of supervisors.
• EBA recommendations
The recommendation of the EBA is in part a further developed version of the Basel Committee’s
recommendation. EBA confirms the institutions’ requirements on corporate governance, and in par-
ticular call attention to:
• the responsibility of management bodies in the quality of governance;
• the significance of a robust control and supervisory function, potentially challenging the decision
processes of the management;
• the importance of adequate risk management strategies and frameworks.
According to EBA, corporate governance concerns and includes all standards and principles
concerned with setting an institution’s objectives, strategies and risk management framework. It in-
cludes how its business is organised; how responsibilities and authority are allocated; how informa-
tion is conveyed within the company; and how the internal control framework is implemented, in-
cluding accounting aspects and remuneration policies.
EBA’s recommendation has been implemented by several national central banks in their own
recommendations. For example, Recommendation No. 5/2016 (VI.06) of the Central Bank of Hun-
gary on the establishment of internal lines of defense, their operation, and the management and
control functions of financial institutions is such an implementation, which lays down as a general
principle that financial institutions shall develop and operate their internal lines of defense and the
specific elements forming their parts in compliance with relevant legislation, in line with the nature
of the applied business model, and the characteristic features - including characteristics inherent in
the organisational form - the extent, the complexity and the risks of the service providing activities
pursued by the institution/group. This applies to internal policies, regulations, organisational solu-
tions required by the Recommendation, as well as implemented practices and procedures.
5. Conclusions and Perspectives of Further Research
The global financial crisis started in 2007-2008 was a collapse which could have been at least
mitigated by an appropriate regulatory environment. The real question is, though, whether the next
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credit crisis, which is threatening the global economy again, can be avoided. Avoidance and pre-
vention are greatly promoted by the improving eectiveness or bank controlling tools and methods,
and their continuous development, and consumer protection rules due to external controls. It is im-
portant to highlight the changes and a tightening of controlling principles pertaining to the risk clas-
sification of borrowers.
It is a definitely positive development that on the basis of bank data - although there might be
mounting tensions and imbalances both in the balance sheets of individual banks and the global
banking system - credit institutions have taken a more balanced and more sustainable course af-
ter the crisis. According to the latest global report of McKinsey (2018), the financial system moved
«from the brink of chaos to a solid ground with a higher level of safety». In numerical terms, this
move means the following:
• The global Tier 1 capital ratio increased from 9.8 percent in 2007 to 13.2 percent in 2017.
• The ratio of tangible equity to tangible assets has increased from 4.6 percent in 2010 to 6.2 per-
cent in 2017.
• Global banking industry market capitalization increased from $5.8 trillion in 2010 to $8.5 trillion
in 2017.
• The return on equity of the global banking system increased to a level of 15 to 18 per cent in the
years preceding the crisis, which posed a serious sustainability hazard. Naturally, the financial
crisis caused a significant decrease in this respect, but, at the same time, the fact that the return
rate has been steadily in the 8 to 10 per cent zone for years after the crisis ended implies a gro-
wing stability of processes and banks’ operation, that is, since 2010 either unsustainably high or
low values indicating insucient return are not typical, in which a more robust controlling acti-
vity could have played a role.
Although internal controls are obviously helpful in avoiding a credit crisis, the signs of indebted-
ness have appeared again in the economy, because economic growth driven by higher consump-
tion has been present in the 10 years since the crisis, but there are limiting factors and sets of rules
which produce a more mixed picture. Today, an excessive outflow of credit is already limited and
curbed by several regulatory elements. The application of capital requirements of financial institu-
tions as a macroprudential policy measure has been taking on increasing prominence as policy-
makers wish to reduce procyclicality and leverage by these means (Yellen, 2010).
Several possible regulatory instruments are used eectively in order to limit an excessive outflow
of retail loans. International experience demonstrates that a combined application of regulations
Figure 2:
Return on equity of the global banking system
Source: McKinsey, 2017
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pertaining to the ratios of monthly instalments to monthly income (Payment to Income - PTI) and
maximum Loan to Value (LTV) ratios is the most eective. The main reason for this is that these li-
mits aect all transactions indirectly and in an administrative manner (as opposed to capital buf-
fers applied as indirect incentives) and aect the entire financial intermediary system, thus cannot
be avoided either by cross-border financial services or lending via branch oces (Baracsi, Grosz, &
Fáykiss, 2015). Parallel with that regulatory instruments supporting the competition between banks
must be nurtured during a boom, but regulations targeted to intensify competition could be poten-
tially relaxed during an economic downturn or financial crisis (A. R. Admati, 2019).
Eective auditing and monitoring tools before lending, with the help of which financial institutions
become able to avoid over-lending to clients with a high risk profile, are also worth highlighting. It
becomes possible to stabilise the operation of banks and financial institutions through the positive
eects of credit monitoring and a strictly regulated environment. The fact that several internatio nal
organisations have adopted recommendations after the crisis to promote an adequate quality of
banks’ governance also contributes to a stricter operation of banks. In this respect, the CRD Direc-
tive, and the recommendations of the Basel Committee and EBA have been of crucial importance.
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Received 20.10.2018
Received in revised form 20.03.2019
Accepted 25.03.2019
Available online 20.08.2019
