The governance of banks in transition economies Moldova country report

December 2011

MOLDOVA COUNTRY REPORT – December 2011

Content

Content ................................................................................................................................. 2

Foreword .............................................................................................................................. 1

A. Introduction and overview of the banking system in Moldova .......................................... 2

1) Introduction ......................................................................................................................... 2

2) Overview of the corporate governance of banks in Moldova ............................................ 2

B. Executive summary .......................................................................................................... 7

1) Legal framework .................................................................................................................. 7

2) Supervisory practice ............................................................................................................ 8

3) Bank practice ....................................................................................................................... 9

4) Key recommendations ....................................................................................................... 10

5) Overall assessment of the corporate governance of banks in Moldova ........................... 11

C. Analysis of the strengths and weaknesses of the corporate governance of banks in Moldova ........................................................................................................................ 15

1) The strategic and governance role of the board ............................................................... 15

2) Composition and functioning of the board of directors ................................................... 19

3) Risk governance ................................................................................................................. 23

4) Internal control .................................................................................................................. 25

5) Incentives and compensation ............................................................................................ 30

6) Transparency to the market and regulators ..................................................................... 31

This Report does not constitute legal advice. Readers are advised to seek appropriate legal advice before entering into any transaction, making any determination or taking any action related to matters discussed herein. The contents of this Report are copyrighted. The assessments and views expressed in the Report are not necessarily those of the EBRD. All assessments and data in the Report are based on information gathered in the course of 2011.

For information or comments please contact Gian Piero Cigna at cignag@ebrd.com

-

The team is grateful for the assistance provided by all parties interviewed. In particular, the team would like to acknowledge the precious assistance offered by the law firms Gladei & Partners (http://www.gladei.md) and Turcan Cazac (http://www.turcanlaw.md).

Moldova Country Report – December 2011 Page 1 of 33

Foreword

1. In July 2010, the Legal Transition Team of the EBRD launched a comparative assessment of the corporate governance of banks in its countries of operations. The overall objective of the assessment is to inform and support the EBRD’s policy dialogue with authorities with a view to generating further commitment to improve the corporate governance of banks in EBRD countries of operations. The assessment aims at providing the EBRD with an overview of the legal and regulatory framework governing the corporate governance of banks and how diligently the various rules and best practice guidelines are implemented.

2. The assessment focuses mostly on internal corporate governance arrangements in banks, particularly the role and composition of boards. It analyses the legal and regulatory framework; its implementation by supervisors; and the practices developed by the systemically important banks in each country. The transparency of governance arrangements to the supervisory authority and the markets is also reviewed. While the assessment analyses banks and their boards, and considers ownership structure and patterns in the banking sector, broader governance issues covered in the OECD Principles such as shareholder and stakeholder rights and responsibilities as well as equity market issues are not dealt with in any detail.

3. To enhance the EBRD’s understanding of the corporate governance of banks in countries of operations, countries reviewed are subjectively rated. For this purpose, the legal framework, supervisory practice and banking practice are given an overall score in the executive summary section of each Country Report. In addition, the performance of countries in the key areas mapped out in the EBRD checklist is also rated and included in the executive summary section of each Country Report. The rating approach is detailed in the box below.

Rating

“strong to very strong” - The corporate governance framework / practices of supervisory authorities / practices of banks are fit for purpose and are close to best practice. “moderately strong” - Most parts of the corporate governance framework / practices of supervisory authorities / practices of banks are adequate but further reform is needed. “weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain some elements of good practice but overall the system is in need of reform. “very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain significant risks and are in need of significant reform.

4. Each Country Report is divided into three Sections: (A) Methodology and overview of the banking system; (B) Executive summary; (C) Analysis of key strengths and weaknesses of the corporate governance of banks and policy recommendations where appropriate.

Moldova Country Report – December 2011 Page 2 of 33

A. Introduction and overview of the banking system in Moldova

1) Introduction

5. The analysis and recommendations contained in this report are based on responses to written questionnaires sent to two Moldovan law firms; the National Bank of Moldova, (the national banking regulator, hereafter the ‘NBM’); the Association of Banks of Moldova; and three among the larger banks in the country (the ‘Banks Reviewed’). Responses to the questionnaires were complemented by face-to-face interviews carried out in Chisinau in July 2011 during which the EBRD assessment team met with respondents to the questionnaires, as well as representatives of the Moldovan National Commission for Financial Market.

6. Based on a best practice assessment check list, the questionnaires and interviews inquired about the legal and regulatory framework on bank governance, supervisory practice and the practice of the Banks Reviewed.

Exhibit 1: The six largest banks in Moldova by share of net assets of the Moldovan banking system at the end of 2010

Bank name (six largest banks) Share of total asset of banking

system (%) * Listing

1. Moldova Agroindbank 19.8 Moldovan Stock Exchange (MSE)

2. Victoriabank 16.7 MSE

3. Banca de Economii 12.5 MSE

4. Moldindconbank 12.1 MSE

5. Eximbank – Gruppo Veneto Banca 8.1 -

6. Mobiasbanca – Groupe Societe Generale

6.9 MSE

Total six largest banks 76.1

Total banking system 100

Based on 2010 Annual report of the NBM and 2010 Annual Reports of each bank *(Total Assets of Bank/Total Asset of sector)*100

2) Overview of the corporate governance of banks in Moldova

7. According to the EBRD Strategy for Moldova, following a decade of economic growth, the Moldovan economy was seriously affected by the global economic crisis and contracted by 6.5% in 2009. While the financial sector has remained stable, domestic credit declined in nominal terms. The policy response has mostly been based on monetary policy, including refinancing rate cuts to a historic low of 5% in January 2010 and lower reserve requirements for commercial banks. The NBM also used its international reserves to avoid depreciation of the Moldovan Leu (local currency, MDL) in 2009. A recovery of the Moldovan economy has started in the first half of 2010.1

1 EBRD Strategy for Moldova, 2010-2013, see at: http://www.ebrd.com/downloads/country/strategy/moldova.pdf

Moldova Country Report – December 2011 Page 3 of 33

8. The Moldovan banking system proved relatively resilient during the financial crisis. This was in large part due to the conservative business model of financial institutions operating in Moldova, which are mostly retail banks with limited mortgage lending and conservative treasury management. According to the 2010 NBM Annual Report,2 the recent financial crisis affected indirectly the banking sector in Moldova via sharp reduction in remittances from abroad, reduced consumption on the internal and external markets which lead to payment failures by the debtors. However, the NBM considers that the banking sector is on the fast route to recovery with the declared net profit for 2010 at MDL 219 million (appx. Euro 12.8 million)3. The majority of banks’ profit is based on interests and fees from crediting activity.4 In 2008-2009 one of the smaller banks, Investprivatbank S.A, failed and was taken into administration by the NBM. Major causes cited by both the NBM and the press were inadequate bank management and misguided risk management due to a concentrated focus on construction industry, which was hardly affected by the crisis.5 It appears that the NBM has led a policy of bank consolidation by gradually increasing the required tier-one capital from MDL 32 million in 2002 to MDL 100 million (appx. Euro 5.85 Million) in 2010.6 The tier-one capital requirement will rise to MDL 200 million (appx. Euro 11.7 million) towards the end of 2012. The NBM reports that the capital adequacy ratio maintained by the banks in 2010 was at 30.1%, when the minimum required is 12%.

9. At the end of 2010 there were 15 licensed banks in Moldova, including four subsidiaries of foreign banks. According to the information in the 2010 BNM Annual Report, 5 of the 15 banks are entirely owned by foreign investors, 2 entirely by local shareholders and 8 by both foreign and local shareholders. The largest foreign investors in Moldovan banks are: the EBRD; banking groups from Italy, France, Romania and Slovenia; and corporate investors mainly from Austria, Germany, US, Russia and Greece.7 Based on 2010 BSCEE Report8, the ownership structure of the financial institutions on the basis of banking assets in Moldova was as follows: 42.5% in foreign ownership; 57.5% in domestic ownership, of which 7.2% is in public sector ownership.

2 The NBM 2010 Annual Report, see at: http://bnm.md/en/annual_report

3 at NBM exchange rate of 1 EURO = 17.0968 MDL, as of 2 May 2011 (this exchange rate shall be used throughout this

paper) 4 The NBM 2010 Annual Report, p. 59, 61, 66, see at: http://bnm.md/en/annual_report)

5 See at: http://www.azi.md/en/story/3834 ; http://www.ipb.md/content/5/comunicat.pdf

6 The NBM 2010 Annual Report, p. 6; Regulation on risk-weighted capital adequacy, Art. 9-10, see at:

http://bnm.md/en/regulations_surveillance 7 The NBM 2010 Annual Report, page 62, see at: http://bnm.md/en/annual_report. No information is available about

overall public ownership in banks as opposed to private 8 BSCEE stands for Banking Supervisors from Central and Eastern Europe. The Report is available at:

http://www.bscee.org/bins/B%20S%20C%20E%20E%20Review%202010_tcm23-27745.pdf

Moldova Country Report – December 2011 Page 4 of 33

Exhibit 2: Ownership structure of the financial institutions on the basis of assets total %

Based on 2010 BSCEE Review

9

10. Net credits held the highest share (55.2%) in total assets, 4.5 % higher than at the end of 2009. In the context of distribution of risks and of destination of investment operations, loans to industry and trade held the highest share (51.65%) in the total loans portfolio, being followed by loans to agriculture and food industry (14.9%); loans for real estate, construction and development (12.3%); consumer loans (8.4%) and other loans (5.5%). The portfolio structure has not essentially changed compared to the previous year end. The share of bad loans (substandard, doubtful and compromised) constituted 13.3% of total loans at the end of 2010, or 3.1% points less compared to the end of 2009. 10

Supervisory framework

11. The main supervisory authority for the banking sector in Moldova is the National Bank of Moldova ('NBM'). Based on Law on National Bank, the NBM is responsible for monetary policy; economic and monetary analysis; licensing and regulation of financial sector; and currency monitoring and regulation. The NBM is the only body that has the power to license, supervise and regulate financial institutions in Moldova. In particular, the NBM may issue regulatory acts: to perform controls and inspections of financial institutions; to require information; and to apply sanctions and remedial measures.

12. In order to monitor and supervise banks’ activity in the securities market and related risks, the NBM collaborates with the National Commission of Financial Market ('NCFM'). The NCFM establishes rules for the organisation and governance of issuers, issue and circulation of securities, as well as securities markets participants’ behaviour. In particular, the NCFM monitors compliance by the issuers with financial reporting and public disclosure requirements. The NCFM monitors and publishes the following information about the issuers (including all banks): share capital; number of shareholders; dividends; cash reserves; financial information; assets; types of shares and traded shares; profits; and calculated tax. 11

13. The Moldovan Stock Exchange (‘MSE’) is the official stock exchange in Moldova. In 2010, the total volume of transactions on the MSE amounted to 2,600 transactions worth approx.

9 BSCEE 2010 Report, p. 164, see at: http://www.bscee.org/bins/B%20S%20C%20E%20E%20Review%202010_tcm23-

27745.pdf 10

BSCEE 2010 Report, p. 156. 11

The compilation of disclosure reports by the banks see at: http://www.cnpf.md/md/anact/ (N/A in English)

Moldova Country Report – December 2011 Page 5 of 33

USD 22 million.12 The MSE keeps two lists of issuers: listed and non-listed. The non-listed issuers are admitted to trading on the MSE but do not need to comply with listing requirements.13 As of March 2011, there are 13 listed issuers14 and 972 non-listed issuers.15 All 15 licensed banks in Moldova are registered with the MSE, of which only six are listed.16

12

Moldovan Stock Exchange, Statistics, at: http://www.moldse.md/ 13

According to Moldovan regulations all trade in the shares of all Moldovan issuers must be carried via the Moldovan Stock Exchange, with minor exceptions (e.g., transactions with less than 0.1% of shares of an issuer). As a result all Moldovan issuers had to register with the MSE and trade their shares via the MSE, this is particularly cumbersome for selling shares to identified potential investor, since direct sale of shares is impossible. All such issuers are considered "non-listed issuers" registered with the MSE. However, issuers who comply with listing requirements of the MSE, which include higher than established in the law criteria for disclosure and some additional financial parameters, may apply for being included in the listing of the MSE. The advantages of being listed as opposed to non-listed are not clear, apart from presumably, a better image of the company. 14

Moldovan Stock Exchange, at: http://internal.moldse.md/default.htm, path: Listing, List of Issuers, which securities are included to the MSE Listing. 15

Moldovan Stock Exchange, at: http://internal.moldse.md/default_rom.htm (MD only); path: Non-Listing, Lista valorilor mobiliare admise spre circulatie la Bursa de Valori a Moldovei. 16

Moldova-Agroindbank, Banca de Economii, Banca Sociala, Mobiasbanca-Groupe Societe Generale, Moldindconbank and Victoriabank. Source: Moldovan Stock Exchange.

Moldova Country Report – December 2011 Page 6 of 33

Laws and regulations relevant for corporate governance of banks

14. The corporate governance of banks in Moldova is regulated by a body of legislative, regulatory and voluntary norms. The box below briefly describes the key documents regulating the governance of banks.

Exhibit 3: Laws and regulation relevant for corporate governance of banks17 18

Law on Financial Institutions (1995, as amended): establishes the principles for establishing, carrying out crediting business and liquidation of credit institutions. The law is the primary source of all main rules regarding organisation of credit activity.

Law on Joint Stock Companies (1997, as amended): regulates the setting up and the functioning of the joint stock companies (‘JSC’) and sets out most of the corporate governance rules in Moldova. The act specifically requires a two-tier governance system for banks.

Law on National Bank of Moldova (1995, as amended): sets out the responsibility, authority and supervisory powers of the NBM.

Law on Securities Market (1998, as amended): establishes detailed disclosure requirements for the issuers, conflicts of interest rules and transactions with affiliated parties.

NBM Regulation on internal control systems in banks (2010): stipulates the requirements on elaboration, organisation, implementation and control of internal control systems in banks, risk management and elements of corporate governance. The Regulation requires that all banks adopt a corporate governance code.

NBM Regulation on the requirements in relation to the administrators of banks (2011): includes provisions setting up the criteria and requirements for members of the supervisory board, management board, audit commissions and chief accountants of banks.

NBM Regulation on transactions with persons affiliated to the bank (2009): sets forth the definition of affiliated persons and the procedures and statutory limits for transactions with affiliated persons.

NBM Regulation on disclosure of financial information by licensed banks in Moldova (2000, as amended).

NBM Regulation regarding the qualification certificate for auditors of financial institutions, (1996, as amended).

Corporate Governance Code (approved by the National Commission for Financial Market, 2007): includes a voluntary set of rules on corporate governance, only recommending (and not requiring) the “comply or explain” rule.

17

All Laws and Regulations of Moldova are available to the public via government database, regularly updated, at: http://lex.justice.md/ (only in Romanian and Russian) 18

Most laws and regulations relevant for the financial sector are available on the NBM webpage, see at: http://www.bnm.md/en/legislation

Moldova Country Report – December 2011 Page 7 of 33

B. Executive summary

1) Legal framework

Key strengths

15. Moldova has developed the main legal tools for regulating corporate governance of banks. The country has a comprehensive company law and a banking law which regulates most aspects of bank governance. The recently adopted Regulation on Internal Control establishes a comprehensive regulatory framework on internal control and risk management in financial organisations. A few other banking and company regulations also include a number of important disclosure requirements to the public and supervisory authority.

16. In line with the new initiative by the NBM and the NCFM, the JSC Law and the Regulation on Internal Control require all banks to adopt corporate governance codes. This may provide a valuable first step in promoting good corporate governance values, once adequate enforcement mechanisms are established.

Key weaknesses

17. Under Moldovan company law, the default rule is that the general meeting of shareholders appoints the supervisory board, the CEO and the executive board, as well as decides the strategy and annual budget of the bank. This gives an unclear signal as to the role of the supervisory boards: in the event the general meeting of shareholders decides to keep the default rule and retain the authority to appoint the CEO and the executive board, the supervisory board has no real leverage for meaningful oversight of the senior management. In the same vein, if the shareholders retain the authority to approve the budget and bank strategy, the supervisory board becomes a mere formality, rather than a strategic and overseeing body responsible and accountable for these matters.

18. The law requires the majority of supervisory board members to be non-affiliated. The underpinning rationale for this requirement is not entirely clear: it may serve to keep the shareholders out of the sphere of governing the bank, thereby reducing any potential for conflicts of interest. International practice recommends having independent directors on board/board committees in order to assist the board in maintaining a wider and impartial view on certain delicate matters, particularly where the potential for conflicts of interest is high. The independent directors are particularly valuable in board committees where the mix of independence and specific qualifications is key in dealing with technical matters potentials for conflicts of interests. In Moldova instead, there is no requirement that independent directors should sit in board committees and no requirement for specific qualification of independent directors so to be able to adequately perform their functions.

19. Neither the law19 nor local practice has developed clear, robust standards for directors’ duties of care and loyalty. Our analysis has shown that Moldova has not developed a general duty for bank directors (i.e., supervisory board members) to safeguard the long-

19

It should be mentioned that the Law on Joint Stock Companies stipulates that the relation between members of the board and company rules is structured as a mandate, though it do not provide explicitly fiduciary obligations of members of the board (paragraph (7) Article 66). The Civil Code regulates in detail this structure.

Moldova Country Report – December 2011 Page 8 of 33

term solvency and the liquidity of the institution. The fragmented legal provisions detailing these duties do not appear to work in practice. This can cause shareholders to lose their trust in directors, including independent directors, and ultimately circumvent the board where important decisions are taken.

20. The internal control system does not appear to be well functioning. The audit commission (“censors commission”) is generally perceived as a dormant body or in best-case scenario another layer of internal control reporting directly to the shareholders. The audit commission includes the necessary expertise, but does not assist the supervisory board in its oversight duty over the internal control system as – in practice - it primarily reports to the shareholders meeting. On the other hand, the overall responsibility for organising and supervising the adequacy of the internal control systems, financial reporting and accounting policies lies with the supervisory board, which is not required to include specific expertise and does not receive adequate support from the audit commission.20 An audit committee at the supervisory board level, comprising experienced independent members who would focus on the internal control issues and then report and vote on such issues within the supervisory board might be more effective.

21. The legislation in force does not establish clear mechanism to provide disclosure of beneficial ownership and affiliated parties disclosures. Banks are required to submit a considerable amount of documents to the supervisor, but it is not clear how this mass of documentation is processed, which seems also to cause a “box-ticking” approach. As a consequence, disclosure is not perceived by stakeholders as effective in revealing the web of relationships among shareholders, bank administrators and their affiliates.

2) Supervisory practice

Key strengths

22. The National Bank of Moldova (‘NBM’) is the only banking regulator in Moldova, which has exclusive competence for licensing credit institutions. The NBM has full access to banks’ internal documents, approves all bank administrators, including supervisory and executive board members, and performs regular on-site supervision. The NBM closely monitors the banks and ensures that they approve all necessary internal documentation and regularly report to the NBM.

23. The NBM is responsible for the prudential supervision of credit institutions operating in Moldova and oversees the adequacy of systems and controls in individual banks. Responses to questionnaires and interviews confirmed that the NBM is a respected supervisor able to exercise these authorities, when needed. The NBM is also pro-active in promoting corporate governance values and in requiring banks to remedy inconsistencies.

20

According to Art. 20 of the Law on Financial Institutions and Art. 71 and 72 of the Law on Joint Stock Companies, the

audit commission has the authority to evaluate the functioning of the internal control system of the bank; to evaluate the internal audit’s activity; to examine the control reports of the internal audit, including its recommendations and the ways of their implementation; to collaborate with external auditors; to determine the security and correctness of the information submitted to the bank’s management and external users; and to elaborate recommendations for bank’s management in order to select the external audit. The commission submits reports to the board and to general meeting of the shareholders. It is not a board committee and it cannot be not made of board members.

Moldova Country Report – December 2011 Page 9 of 33

Key weaknesses

24. The Law on Financial Institution21 assigns to the supervisory board the authority to approve the banks’ internal bylaws. This, coupled with a quite strict approach by the NBM contributes to weaken the strategic role of the board, being busy in approving bank’s internal policies, including a number of non-strategic documents. This significantly reduces the time that the board can dedicate to key strategic issues. Ideally, the board should have the overall responsibility for the design and approval of the strategic objectives, the bank’s risk appetite and key policies and for overseeing their implementation.22 Operational matters should be left to the executive body of the bank.

25. The lack of banking experience on the banks' supervisory boards is sometimes of concern, and can mine the board’s ability to deal with ever-rising complexity of banking activity.

3) Bank practice

Key strengths

26. Overall the Moldovan banking system endeavours to establish sound corporate governance structures. Banks have developed corporate governance codes and terms of references clearly defining banks’ functions and responsibilities. Moldovan banks have established separate internal audit and risk governance systems aiming at monitoring the financial health of the banks.

Key weaknesses

27. The boards of the banks reviewed do not seem to include sufficient banking experience, to allow the board to adequately perform its functions. The functioning of the boards is further hampered by the need to approve a multitude of internal technical documentation. It is generally accepted that boards which are involved in operational matters often find themselves with less time available for discussions of strategy. Likewise, boards that are suffering from ‘information overload’ regarding operational matters will also find it harder to concentrate on the major strategic issues.

28. Banks generally do not appear to perform board evaluations with a view to assessing the board performance and ensuring that the board has the necessary mix of skills for the performance of its key functions. Furthermore, banks do not seem to establish nomination polices, to reflect the skills required at the board and to ensure transparency in the appointment process.

29. Notwithstanding the various legal regulations,23 the potential for conflicts of interests is high due to the network of relationships among shareholders, administrators and their

21

Art. 17 (2) of the Law on Financial Institutions states that Each bank shall be governed by internal by-laws, approved its Board of Directors which in compliance with its charter shall establish: a) the structural organization and functions of bank, including administration control units and their jurisdictions; b) sub-units functions, supervisory positions of the employees; c) the limits of authority administrators and other employees bank to engage in financial activities in the name and for the account of the bank; d) the functions of Audit Committee and other permanent committees. 22

Principles for enhancing corporate governance by the Basel Committee on Banking Supervision, 2010, Principle 1, page 7. 23

For instance, Art. 24 of the Law on Financial Institutions and the Regulation on bank transactions with its affiliated persons.

Moldova Country Report – December 2011 Page 10 of 33

affiliates. Additionally, in a few banks representatives of the senior management of large bank’s clients sit on the board, which increases the potential for conflict of interests.

30. Banks do not have remuneration policies and do not seem to link their compensation systems to prudent risk management. Although bank compensation practices do not seem to lead to excessive risk taking, the regulator and the banks should develop criteria for remuneration, thereby shaping a more sound banking system.

4) Key recommendations

31. The following box is a summary of the recommendations contained in Section (C) below, which aim to address some of the weaknesses identified in this Country Report. The purpose of these recommendations is to assist the EBRD in identifying priority areas for policy dialogue.

Legal framework

1. The law should clarify the role of supervisory board and expressly delegate to the board the responsibility to appoint the executive board, and to approve the bank strategy and annual budget. The framework should establish clear lines of responsibility and accountability between key corporate bodies.

2. Banking law should consider removing the requirement for boards to have a majority of non-affiliated members and rather require the appointment of a sufficient number of qualified independent directors, commensurate with the size of the board. Independent directors should also serve on board committees.

3. The legal framework should clearly establish: board members’ duties of loyalty and care to the bank; the duty to preserve the long-term solvency of the bank; and clear responsibility for failure to discharge their duties. Explanatory soft law (guidelines) may accompany such rules to ensure adequate understanding and implementation.

4. The audit commission structure and composition should be re-considered with a view to understanding if the presence of “outsiders” makes the body effective. The legislator should also consider whether it is appropriate for the audit commission to become a proper board committee (reporting to the supervisory board and not the general shareholders meeting) and include [a majority of] independent and qualified supervisory board directors. The audit commission as a whole should have recent and relevant experience commensurate with the functions assigned to the commission. At least one member, ideally the chair, should have specialist knowledge and experience in the application of accounting principles and internal control processes.

Supervisory practice

5. The NBM should develop mechanisms for monitoring implementation of banks’ corporate governance codes. The supervisor might consider the "comply or explain" approach.

6. The supervisor should encourage financial/banking, and not only economic expertise on the boards.

Moldova Country Report – December 2011 Page 11 of 33

7. The supervisor should also evaluate the appropriateness of the mix of skills required of the board to fulfil its responsibilities.

8. The NBM should allow the delegation of functions which are not of strategic nature, from the supervisory board to senior executives.

9. The supervisor should review the effectiveness of its approach in identifying related parties and conflicts of interests, with the aim of preventing abusive transactions with related parties and non-transparent governance structures within banks.

Bank practice

10. Banks should uphold the strategic and oversight role of supervisory boards by vesting boards with powers to approve strategic decisions, appointment and monitoring of senior executives and by staffing boards with necessary skills.

11. Banks should perform board evaluations with a view to improving performance and identifying the skills necessary for the board. This information should also be used for preparing the nomination policies and criteria for recruiting new board members.

12. Systemically important banks should be required to adopt a forward-looking statement on risk appetite. The risk appetite should be communicated to the NBM.

13. Banks should develop sound executive remuneration policies based on both bank and individual performance and prudent risk management.

5) Overall assessment of the corporate governance of banks in Moldova

32. The following table provides an indicative rating of Moldova’s performance in the key governance areas mapped out in the EBRD best practice assessment checklist. Rating in this table is subjective and based on the overall assessment of the strengths and weaknesses of the legal framework, supervisory practice and the practice of banks as discussed in section C below. The rating also reflects our assessment of the legal framework, supervisory practice and the practice of banks compared to international best practice standards.24

24

Best practice standards used in our assessment: Basel Committee on Banking Supervision, Principles for enhancing corporate governance, (2010); Basel Committee on Banking Supervision, Enhancing corporate governance for banking organisations, (2006); EBRD, OECD, Corporate Governance of Banks in Eurasia, (2008); OECD, OECD Principles of Corporate Governance, (2004); European Commission, Corporate governance in financial institutions and remuneration policies, (2010); Institute of International Finance, Final Report of the IIF Committee on Market Best Practices: Principles of Conduct and Best Practice Recommendations, (2008); Netherlands Bankers’ Association, Banking Code, (2009)

Moldova Country Report – December 2011 Page 12 of 33

Issues Score25

The strategic and governance role of the board

Strategic role of the board

Do boards have a sufficiently active role in developing and approving the strategic objectives and the budget of their banks?

Weak

Do boards effectively review and evaluate management performance against agreed budgetary targets?

Weak

Governance role of the board

Do boards effectively shape the governance framework and corporate values throughout their organisation?

Weak

Are boards of subsidiaries in a position to effectively control the operation of their banks?

Weak

Is there adequate transfer of good practice between parents and subsidiaries? Moderately

strong

Board composition and functioning

Size, composition and qualification

Is the size of boards adequate to meet the requirements of their business? Moderately

strong

Are directors qualified for their position? Weak

Is the board sufficiently independent from management and controlling shareholders?

Weak

Are the duties of directors to their banks, shareholders and stakeholders clearly set out?

Weak

Is there adequate balance of power between individuals within boards and are there adequate checks to maintain the balance?

Weak

Do board chairs possess relevant banking and/or financial industry experience and a track record of successful leadership?

Very weak

Do current tenure patterns of board directors suggest a high level of engagement and independence?

Weak

Do boards provide adequate induction and professional development to their members?

Very weak

Nomination committees

Is the process for director succession and nomination sufficiently transparent? Very weak

Functioning and evaluation

Are the responsibilities, authorities, and terms of reference of boards and board committees clearly defined and documented?

Moderately strong

Do boards function in ways that encourage informed contribution and constructive challenge by all directors?

Very weak

25

Where: “strong to very strong” - The corporate governance framework / practices of supervisory authorities / practices of

banks are fit for purpose and are close to best practice. “moderately strong” - Most parts of the corporate governance framework / practices of supervisory authorities /

practices of banks are adequate but further reform is needed “weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain

some elements of good practice but overall the system is in need of reform “very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks

contain significant risks and are in need of significant reform.

Moldova Country Report – December 2011 Page 13 of 33

Issues Score25

Do boards meet regularly? Weak

Are boards and board committees supported by a senior company secretary? Weak

Do boards evaluate their performance and discuss the outcome of such evaluation? Very weak

Risk governance

Risk governance framework

Are boards and their risk committees sufficiently involved in setting the risk appetite and monitoring the risk profile of banks?

Weak

Do banks appoint and empower senior chief risk officers? Moderately

strong

Do senior executives have a sufficiently integrated firm-wide perspective on risk? Moderately

strong

Risk committees

Are boards in a position to effectively review risk management? Very weak

Internal Control

Internal control framework

Does the organisational structure of banks include clearly defined and segregated duties for key officers and effective delegation of authority?

Moderately strong

Are there enough checks and balances to ensure the independence and integrity of financial reporting?

Weak

Are conflicts of interest including related party transactions effectively managed? Weak

Is external auditor independence upheld by boards and their audit committees? Moderately

strong

Have banks established effective internal audit departments? Moderately

strong

Do banks establish effective compliance departments to ensure that they comply with regulatory obligations?

Weak

Do boards and their audit committees effectively oversee and regularly review the effectiveness of the internal control systems?

Weak

Audit committee

Do boards establish audit committees? Very weak

Are audit committees fully independent? Very weak

Do audit committees/board include at least one member with substantial auditing or accounting experience?

Very weak

Incentives and compensation

Remuneration policy

Do boards and their remuneration committees have a sufficient role in shaping the compensation system of their banks?

Very weak

Is remuneration meritocratic and linked to firm and individual performance? Weak

Is senior executive compensation aligned with prudent risk management? Very weak

Remuneration committee

Moldova Country Report – December 2011 Page 14 of 33

Issues Score25

Do boards establish remuneration committees? Very weak

Are remuneration committees independent from management? n/a

Transparency to the market and regulators

Financial statements

Is IFRS required by law or regulation? Moderately

strong

Corporate governance

Do banks report regularly on corporate governance matters? Moderately

strong

Do banks publish key governance information on their website? Moderately

strong

Is disclosure proportionate to size, complexity, ownership structure and risk profile of banks?

Moderately strong

Transparency to regulators

Can the supervisory authority obtain information about ultimate ownership and other corporate governance matters?

Weak

Moldova Country Report – December 2011 Page 15 of 33

C. Analysis of the strengths and weaknesses of the corporate governance of banks in Moldova

1) The strategic and governance role of the board

Key strengths

Legal framework

33. The country's main legal framework for corporate governance is found in the Law on financial institutions and Law on Joint Stock Companies. In line with the new initiative by the NBM and the NCFM, the JSC Law and the Regulation on Internal Control require all banks to adopt corporate governance codes. This may contribute to promoting good corporate governance values, provided that the codes’ implementation is monitored. There is also a national corporate governance code that may serve as guidance on the issues to be included in the bank codes.

34. The banking law clearly establishes the requirement of banks to approve internal regulations detailing the structure of bank governance, competence and responsibilities of the governance bodies. All such internal regulations must be submitted to the NBM.

Supervisory practice

35. The NBM has access to most governance documents of regulated entities as well as the authority to address corporate governance failures and compel appropriate remedial action. These include setting a timetable for compliance and deciding on sanctions for non-compliance.

36. The NBM is currently pursuing an initiative to promote best corporate governance practices in banks. During its on-site and off-site supervisory activities, the NBM pays close attention to any deficiencies in the governance of banks benchmarking practices with banking regulations and bank’s corporate governance rules. The NBM then directs the bank to perform the necessary changes. With time, the NBM hopes that banks will themselves remedy any shortcomings:

“We believe that banks should themselves monitor their compliance with their own corporate governance codes and make any changes that are necessary to reflect such self-imposed rules.”

Banks are encouraged to include a corporate governance section in their annual reports, reporting on their compliance with their corporate governance codes.

Bank practice

37. Our review has revealed that banks generally adopt corporate governance codes or policies setting out the responsibilities of the governing bodies and outlining their bank governance structure and principles. Some banks have also approved codes of ethics.

38. The analysis has also revealed that in a number of banks the supervisory board is responsible for approving the multi-year strategy and annual budget, fulfilling its strategic role and guiding the bank in its use of resources and development.

Moldova Country Report – December 2011 Page 16 of 33

Key weaknesses

Legal framework:

39. The Moldovan Company and Banking Laws require banks to adopt a two-tier structure. However, the laws fail to assign a clear role to the supervisory board. The law leaves it to the discretion of the bank to assign strategic responsibilities, such as the approval of the annual budget and bank strategy, and the appointment of the executive board, either to the general meeting of shareholders or the supervisory board. There is therefore the possibility that the supervisory board is left with no authority and responsibility to decide the course of the bank and the way its financial resources are deployed, and with no leverage in its oversight of the implementation of the banks' strategic objectives. Furthermore, if the executive board is appointed by the general meeting of shareholders, the decision-making may, in practice, concentrate in the hands of the executive body bypassing the board. Best international practices recommend that the board should have overall responsibility for overseeing the implementation of the bank’s strategic objectives.26

40. Our analysis has revealed that some banks have opted out of the default rule mentioned above (i.e., the general meeting of shareholders appointing both the supervisory board and the executive board) and have assigned to the supervisory board the authority to approve the strategy and annual budget of the bank. However, the bank practice varies widely.

41. The Law on Financial Institutions requires that the supervisory boards annually review and approve all internal regulations, rules and procedures. There is a risk that this approach transforms the supervisory boards into a mere “rubber-stamping” body, leaving it with little time to deal with the bank’s strategic issues. The NBM is aware of the issue and intends to remedy the situation.

Supervisory practice

42. The NBM does not require the parent/group of systemically important subsidiaries to adopt a governance policy for the group describing the relationship between the group and its Moldovan subsidiary. The NBM’s approach is that

“since the subsidiaries are independent legal entities registered on the territory of Moldova these should be treated as such.”

In practice, it is the group that decides the strategy and risk position of the subsidiary. It is critical that the supervising authority is aware of the influence the group has over the subsidiary. 27

26

Principles for enhancing corporate governance by the Basel Committee on Banking Supervision, 2010, Principle 1, page 7. 27

Best practices recommend the parent, in order to fulfil its internal governance responsibilities, to: (a) establish a governance structure which contributes to the effective oversight of its subsidiaries and takes into account the nature, scale and complexity of the different risks to which the group and its subsidiaries are exposed; (b) approve an internal governance policy at the group level for its subsidiaries, which includes the commitment to meet all applicable governance requirements; (c) ensure that enough resources are available for each subsidiary to meet both group standards and local governance standards; (d) have appropriate means to monitor that each subsidiary complies with all applicable internal governance requirements; and (e) ensure that reporting lines in a group should be clear and transparent, especially where business lines do not match the legal structure of the group.

Moldova Country Report – December 2011 Page 17 of 33

Bank practice

43. In practice, the strategic role of the supervisory boards in the banks reviewed varies widely. In some banks,28 the general meeting of shareholders appoints the CEO and approves the strategy and budget. The supervisory board does not seem to play any strategic role. In some foreign owned banks, targets and objectives are determined by the group and the strategic policies are developed by the senior executives through a bottom-up approach, leaving a limited role to the subsidiary’s board.

44. Boards’ composition is another factor to be considered. It appears that the majority of board members do not have financial sector experience (see more on board composition below in § 61). As put by one of the interviewees:

“The supervisory boards just approve the policies and rules submitted by the senior management, without many discussions. Most of the members of the supervisory boards are not bankers and it would be difficult for them to put together a strategy or understand the budget of the bank.”

45. The boards’ involvement in setting performance targets for executives and reviewing their performance against strategic targets is unclear. In some banks, the oversight by the supervisory board over management seems a formality. The real power is in the hands of the shareholders.29

46. Taking inspiration from EU legislation,30 Art. 31 of the Accounting Law requires banks to disclose a statement on their compliance with the corporate governance code31 and other key corporate governance information. However, in practice no banks, including those which are listed, appear to file or publish any reports regarding their compliance with the NCFM Corporate Governance Code or detailing in practice the banks compliance with their own codes. There is feeling that the national and the banks’ corporate governance codes are perceived as a mere formality and that they are not used in practice.

Key Recommendations

Legal framework

1. The law should clarify the role of supervisory board and expressly delegate to the board the responsibility to appoint the executive board, and to approve the bank strategy and annual

28

However this applies to a minority of banks. At the time of writing the report, it appears that out of 14 banks in Moldova, only in two of them the executive board has been appointed by the GSM, while in only 4 banks (according to their statute) the banks’ strategy and budget (i.e,, the banks’ annual business plan) are approved by the GSM. 29

See for further guidance on the supervisory authorities of the supervisory board the Principles for enhancing corporate governance by the Basel Committee on Banking Supervision, 2010, Principle 1, page 9. 30

In 2006, the European Commission issued Directive 2006/46/EC, introducing the comply-or-explain principle for the first time in European law. It mandates the application of corporate governance codes by way of comply or explain - or alternatively allows the application of company-specific extra-legal principles (http://eurlex.europa.eu/LexUriServ/site/en/oj/2006/l_224/l_22420060816en00010007.pdf) 31

Article 31 (2) of the Accounting Law requires public interest entities to include a separate document in the management report on corporate governance, to detail a) the corporate governance code applied by the entity with reference to the source and place of publication; b) the extent to which the entity complies or does not comply with the corporate governance code referred to in letter a); c) internal control systems and risk management of the entity and group of entities; d) authorities and rights of governing bodies and owners (associates, participants, shareholders) of the entity as well as how they can be exercised; and e) composition, operation and structure of governing bodies of the entity.

Moldova Country Report – December 2011 Page 18 of 33

budget. This will establish clear line of responsibility and accountability between key corporate bodies.

2. The Law should promote the strategic role of the supervisory boards in banks, so that the supervisory board is charged only with strategic issues, while the approval of internal rules and procedures, of non-strategic nature, can be delegated to senior executives.

Supervisory practice

3. In line with Accounting Law, the NBM should require banks to disclose how banks comply in practice with their corporate governance code (and in case of listed banks, with the National Corporate Governance Code). In case of non-compliance, banks should provide meaningful explanations.

4. The supervisor should require the parent of systemically important subsidiaries to adopt a governance policy for the group, clearly mapping out the relationship between group and subsidiary boards, as well as the relationship between group and subsidiary functions and businesses.

Bank practice

5. Banks should uphold the strategic and supervisory role of supervisory boards firstly by vesting boards with the power to approve strategic decisions, appoint and monitor senior executives and secondly by staffing boards with necessary skills.

Moldova Country Report – December 2011 Page 19 of 33

2) Composition and functioning of the board of directors

Key strengths

Legal framework

52. A recent NBM Regulation on the requirements in relation to the administrators of banks establishes "fit and proper" criteria for supervisory board members, senior management, audit commission members, chief accountant and heads of bank branches (‘Bank Administrators’). The ‘fit and proper’ requirement for supervisory board members is comprehensive, covering the probity of directors, financial soundness, management and economic or financial experience. The Regulation requires that at least one member of the supervisory board and two members of the executive board speak the local language.

53. As regarding the duty of loyalty, the Law on financial institutions expressly requires Bank Administrators to give priority to the interests of the bank over their own personal interests.

Supervisory practice

54. The ‘fit and proper’ requirements are very carefully implemented by the NBM who approves all board directors and senior executives, and has the power to veto appointments. The NBM also reviews board independence, both as part of the approval process and during on-site visits. Banks must submit various documentation regarding the education, experience and affiliation of the candidates to the NBM before they are appointed to the supervisory, executive boards and audit commissions.

Bank practice

55. Our review has shown that supervisory boards appear to be of manageable size (comprising between seven to nine members). 32 However, it appears that not all members are currently operational, due to pending approvals from the NBM.

56. Executives are not allowed to sit on the supervisory board, which is a good practice.

32

"The board should structure itself in a way, including in terms of size, frequency of meetings and the use of committees, so as to promote efficiency, sufficiently deep review of matters, and robust, critical challenge and discussion of issues." Basel Committee’s Principles for enhancing corporate governance - final document, 2010, § 42, see at: http://www.bis.org/publ/bcbs176.pdf. According to the UK Corporate Governance Code "The board should not be so large as to be unwieldy and should be of sufficient size that the requirements of the business can be met and that changes to the board’s composition and that of its committees can be managed without undue disruption", Section B, B1; see at: http://www.frc.org.uk/documents/pagemanager/Corporate_Governance/UK%20Corp%20Gov%20Code%20June%202010.pdf. Further, in the Walker Review of corporate governance in banks in UK it is stated that based on most recent research and behavioural studies that "an “ideal” size [for a bank board is] of 10-12 members, not least on the basis that a larger board is less manageable, however talented the chairman, and that larger size inevitably inhibits the ability of individual directors to contribute", § 3.1, see at: http://webarchive.nationalarchives.gov.uk/+/http://www.hm-treasury.gov.uk/d/walker_review_261109.pdf

Moldova Country Report – December 2011 Page 20 of 33

Key weaknesses

Legal framework

57. As mentioned above, the Law on Financial Institutions requires that the majority of the supervisory board is not affiliated with the bank. The banking regulations definition of affiliation is very comprehensive and excludes, inter alia, persons who directly or indirectly hold 5% stake in the bank. Best international standards recommend that boards include a sufficient number of independent directors to ensure that boards and the board committees are able to make and support objective and unbiased decisions,33 especially where the potential for conflicts of interest is high.34 In this respect, it is necessary that the independence requirement is coupled with appropriate qualification. Further, it is essential that independent directors sit on board committees where more often delicate issues are dealt with (e.g., recommendation on the appointment of the external auditor, remuneration of executives, analysis of the effectiveness of internal control system).

58. In Moldova, the requirement of independence of the majority of supervisory board members appears to be a reflection of the attempt by the regulator to keep shareholders away from directly governing the bank. As explained by a representative of the NBM:

“What we hope to achieve is that banks are governed by entirely independent persons who are trained professional managers and who are not connected to the shareholders. I would love to have banks where even the CEO is independent”

The new Regulation on the requirements in relation to the administrators of banks requires that members of the executive board and audit commission may not be significant shareholders of the bank (5%), nor affiliated to any such shareholder.

59. This approach should be carefully assessed. The requirement that all executive board members and the majority of the supervisory board members should not be affiliated persons seems too rigid. In the majority of jurisdictions, this requirement – often included in the national corporate governance code as a recommendation – is for supervisory board committees and not for the executive and supervisory boards themselves. Shareholders should be able to decide the composition of the supervisory board, provided that the qualification of board members is fit and objectivity in making decision and assessing potentials for conflicts of interests is maintained. This is the rationale behind having audit, risk and remuneration committees made of well qualified and independent non-executives. In Moldova however, there is no requirement that non-affiliated board members should sit on board committees. Furthermore, there is no requirement that the “non-affiliated” members should possess specific expertise to be able to deal with the delicate issues (e.g., audit, remuneration, nomination) potential for conflicts of interests.

60. Responses to questionnaires and interviews indicate that company law and case law have not developed clear, robust standards for directors’ duties of care and loyalty. The interviewees were not aware of any case brought before a court against board members for breaches of duties of loyalty or care, or for bank’s failure as a result of their poor performance. The perception is that the CEO, not the board and its members, is primarily

33

For more information about board committees see Basel Committee’s Principles for enhancing corporate governance, 2010, pages 12 -13, at: http://www.bis.org/publ/bcbs176.pdf 34

For guidance see Basel Committee’s Principles for enhancing corporate governance - final document, 2010, § 38-39.

Moldova Country Report – December 2011 Page 21 of 33

responsible for bank’s failure.35 In view of the NBM's initiative to loosen the shareholders' grip on the administrators of banks, it is of increasing importance that shareholders can hold administrators accountable for their misdeeds.

Supervisory practice

61. There is limited financial and banking experience in supervisory boards. Board members are primarily senior executives of other companies outside the financial sector. Additionally, accounting/auditing experience seems to be present only in the audit commission - which is not a board committee – and not in the supervisory board. The ‘fit and proper’ requirement should ensure that the board as a whole has the necessary mix of skills to properly exercise its functions. Examples of skills that the board should have, or have access to include: finance, accounting, lending, bank operations and payment systems, strategic planning, communications, governance, risk management, internal control, bank regulation, auditing and compliance. The board collectively should also have a reasonable understanding of local, regional and, if appropriate, global economic and market forces and of the legal and regulatory environment.36

Bank practice

62. Our analysis has revealed that the majority of banks do not have a nomination policy for the supervisory board, relying primarily on the general meeting of shareholders to nominate candidates. Accordingly, candidates for the board are not nominated based on criteria identified by the board itself, through an analysis of the skills and experience required to meet the board’s key functions and responsibilities. The OECD Principles recommend that the “board has a key role in identifying potential members for the board with the appropriate knowledge, competencies and expertise to complement the existing skills of the board and thereby improve its value-adding potential for the company”.37

63. Although all respondent banks reported to perform board evaluations, during the interviews it was revealed that such evaluations are meant to be supervisory board’s activity reports to the general meeting of shareholders, rather than assessments carried out internally and discussed among the board members. To ensure satisfactory board performance, best practices recommend that boards carry out regular assessments of the board as a whole as well as of individual board members.38 Evaluations help ensure that the board has the necessary mix of skills and diligence in its performance.39

64. The analysis has revealed that in some of the banks the supervisory boards meet in person four to six times a year and much more frequently in absentia. However, it seems that boards spend most of their time discussing, revising and approving internal regulations and procedures, mostly of technical nature, instead than discussing strategic matters. As such,

35

Basel Committee recommends that "members of the board exercise their “duty of care” and “duty of loyalty” to the bank under applicable national laws and supervisory standards. This includes engaging actively in the major matters of the bank and keeping up with material changes in the bank’s business and the external environment, as well as acting to protect the interests of the bank." For further guidance see: Principles for enhancing corporate governance, (2010), Basel Committee on Banking Supervision, at: http://www.bis.org/publ/bcbs176.pdf 36

Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), page 10. 37

See OECD Principles on corporate governance, 2004, principle 6, D5, p. 61-62, at: http://www.oecd.org/dataoecd/32/18/31557724.pdf 38

Principles for enhancing corporate governance (2010), Basel Committee on Banking Supervision, page 11. 39

Note that board evaluations do not mean monitoring or evaluation by another governance body (e.g., the general meeting of shareholders). In this respect, the recommendation in the National Corporate Governance Code for the supervisory board to evaluate the performance of the management board is not self-evaluation.

Moldova Country Report – December 2011 Page 22 of 33

boards of systemically significant banks may be unable to discharge their duties adequately. The foregoing underlines the formal nature of these boards. As one of the banks indicated:

“Our board has to meet weekly in order to be able to approve all the internal rules and procedures, as well as regularly review such procedures, which are often of very technical nature. This is due to the new requirements by the National Bank of Moldova that these procedures are approved by the supervisory board and cannot be delegated”.

Some respondents reported that 75% to 95% of board meetings are spent approving internal procedures. It is generally accepted that boards which are involved in operational matters often are left with less time to discuss the bank’s strategy. Equally, boards suffering from ‘information overload’ regarding operational matters will find it harder to concentrate on the major strategic issues.

65. Our analysis has revealed that the majority of banks has appointed a corporate secretary, but only a few of them are in charge of assisting board members, the board and board committees in the proper organisation of meetings.40 The absence of a senior corporate secretary in banks may undermine the link between boards and their committees, as well as the audit commission, and restrict the flow of information.

66. As regards directors’ induction and training, it appears from responses to questionnaires and interviews that the majority of banks reviewed have not established programmes of induction and continuous learning and/or training for their board members.

Key Recommendations

Legal framework

1. Policy makers should consider the effectiveness of the provision requiring boards to have a majority of non-affiliated members. The role and functions of non affiliated/independent directors should be clarified. Ideally, banks should be required to have a sufficient number of qualified and independent directors, commensurate with the size of the board. Independent directors should also serve on board committees.

2. The legal framework should clearly set out: board members’ duties of loyalty and care to the bank, the duty to preserve the long-term solvency of the bank, and clear responsibility for failure to discharge their duties. Explanatory soft law (guidelines) may accompany such rules to ensure adequate understanding and implementation of the rules.

3. While members of other banks’ governance bodies are prohibited from sitting on the bank’s supervisory board, an exception should be made for parent/group executives and directors sitting on the subsidiary’s board.

Supervisory practice

4. The supervisor should encourage financial/banking, and not only economic, expertise on the boards. The supervisor should also evaluate the appropriateness of the mix of skills required of the board to fulfil its responsibilities.

40

For guidance on the corporate secretary role and responsibilities, see ICSA Guidance on Corporate Governance Role of the Company Secretary: http://www.icsa.org.uk/assets/files/pdfs/081020%20-%20Corp%20Gov%20role%20of%20co%20sec.pdf

Moldova Country Report – December 2011 Page 23 of 33

Bank practice

5. Banks should consider performing board evaluations as a whole and for each individual with a view to improving performance and identifying the skills necessary for the board. This information should be used for preparing the nomination policies and criteria for recruiting new board members.

6. Banks should consider appointing a senior company secretary for enhancing the effectiveness of board and committees' work.

7. Banks should consider introducing induction and training programmes for directors.

3) Risk governance

Key strengths

Legal framework

67. The regulatory framework on risk governance consists of a network of regulations addressing the general framework and setting out the procedures for various types of risks. The recently enacted Regulation on Internal Control Systems in Banks describes in detail the risk management systems banks must adopt. Banks are required to establish adequate procedures for evaluation, management and monitoring of risks; to create relevant reporting lines and to develop sound policies.

68. The Regulation on Internal Control Systems in Banks clearly requires banks to decide risk limits, depending on a list of factors and monitor their risk profiles. Banks must have specific policies for risks management approved by the supervisory board. Additionally, banks are required to use stress tests to better understand its risk profile.

69. The supervisory board of banks has the overall responsibility of establishing adequate internal control (including risk governance) systems for the banks and monitor their efficiency.

Supervisory practice

70. The NBM closely monitors that banks approve risk management policies and procedures. The supervisory authority requires regular reporting on various types of risks and banks’ risk performance. The NBM reviews, on a monthly basis, banks’ risk profile and meets annually with banks’ risk departments during their on-site inspections.

Bank practice

71. The analysis has revealed that banks generally rigorously comply with the NBM regulations on risk governance and have set up separate risk departments handling risks monitoring and evaluation. Banks’ risk departments adhere to the principle of separation of functions in compliance with NBM regulations. The risk function identifies, measures, monitors risks and participates in setting acceptable levels of risk.

72. The Banks Reviewed have established asset and liability committees (ALCO), operational risk committees and senior credit or credit risk committees. Furthermore, all banks have a

Moldova Country Report – December 2011 Page 24 of 33

designated person overseeing the risk function, most often the head of the risk department who, sits on the management board and reports to the CEO, which may be considered an equivalent of a chief risk officer (‘CRO’). This structure helps banks senior management to have a firm-wide perspective on risk and be aware of latest developments in the market. 41

Key weaknesses

Legal framework

73. Moldovan regulations do not sufficiently highlight the need for the independence of the risk governance function and for the necessary checks and balances to ensure such independence. Best practices suggest that banks should appoint an independent senior executive (i.e., the chief risk officer or equivalent) with distinct responsibility for the bank’s entire risk management function. The CRO or equivalent should be able to communicate directly with the management board concerning adverse developments that may not be consistent with the institution’s risk appetite and tolerance and business strategy. The CRO or equivalent should also be able to report directly to the board or, where appropriate, to the audit committee (or equivalent). Although banks in Moldova appear to appoint an equivalent senior executive, such executive does not seem to have direct access to the supervisory board. To ensure its independence, the CRO should have direct access to the supervisory board and be able to meet the supervisory board members without the presence of senior management.42

Bank practice

74. The composition of bank boards in the Banks Reviewed includes little specific expertise needed for the proper discussion and approval of the banks’ risk appetite and monitoring of the bank’s risk profiles. The process appears to be driven by the banks’ senior management; the board having a mere formal role. As a result, the supervisory role of the board in overseeing risk issues is impaired, thereby exposing banks to higher potential of failures.43 The recent crisis highlighted the damaging consequences of the inability to adequately appreciate banks risks.

75. The law does not require and therefore banks generally do not produce an integrated statement on the bank’s risk appetite. Rather, relevant departments set limits for various types of risks, which are included in credit policies for such departments. Such approach

41

"Risk reporting systems should be dynamic, comprehensive and accurate, and should draw on a range of underlying assumptions. Risk monitoring and reporting should occur not only at the disaggregated level (including risk residing in subsidiaries that could be considered significant), but should also be aggregated upward to allow for a firm-wide or consolidated picture of risk exposures. In this regard, organisational “silos” can impede effective sharing of information across a bank and can result in decisions being made in isolation from the rest of the bank. Overcoming information-sharing obstacles posed by silo structures may require the board and senior management to review or rethink established practices in order to encourage greater communication. Some firms have found it useful to create risk management committees - distinct from the board’s risk committee - that draw members from across the firm (e.g., from business lines and the risk management function) to discuss issues related to firm-wide risks.", Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), §§ 97-98, see at: http://www.bis.org/publ/bcbs176.pdf 42

For further guidance, see CEBS, High level principles for risk management (2010), page 4 (http://www.eba.europa.eu/documents/Publications/Standards---Guidelines/2010/Risk-management/HighLevelprinciplesonriskmanagement.aspx) 43

"The board has ultimate responsibility for the bank’s business, risk strategy and financial soundness, as well as for how the bank organises and governs itself. Accordingly, the board should: [...] approve and oversee the implementation of the bank’s overall risk strategy, including its risk tolerance/appetite..." For further guidance see Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), Principle 1, page 7-8.

Moldova Country Report – December 2011 Page 25 of 33

does not allow the supervisory board to exercise its key strategic responsibility in formulating the bank’s risk appetite. Risk appetite serves to provide clear top-down guidance to risk originators within the bank’s management as to how far they can go in using the bank’s capital within a determined period of time.44

Recommendations

Legal framework

1. The law should provide guidance to banks regarding appointment of a CRO or equivalent senior function. The CRO or equivalent is responsible for the risk management across the bank and for coordinating the activities of other units relating to the bank’s risk management framework. He or she must have direct access to the supervisory board.

Bank practice

2. To improve boards’ ability in deciding and monitoring banks’ risk performance, boards should consider including risk management expertise or be able to access independent expert opinion, when necessary.

3. Systemically important banks should be required to adopt a forward-looking statement on risk appetite. The risk appetite should be communicated to the NBM.

4) Internal control

Key strengths

Legal framework

76. The regulatory framework on internal control appears to be strong and is mostly contained in the NBM's Regulation on Internal Control Systems in Banks, which requires the establishment of independent internal audit and segregation of functions. It also provides guidelines on setting up the internal control mechanisms. The Regulation further requires that the appointment and dismissal of the head of internal audit department is either determined by the supervisory board or is coordinated by the senior management with the supervisory board.

77. Company law and banking regulation explicitly ascribe to the supervisory board and the audit commission the responsibility for ensuring the integrity and quality of financial reporting. In addition, management is required to certify financial statements.

78. Banking regulations include a comprehensive definition of affiliated persons and require appropriate disclosure to identify affiliated persons and prevent abusive related party transactions. Shareholders’ or supervisory board’s authorisation is necessary for most significant related party transactions. The regulations and recent amendments to the law also contain detailed requirements aimed at identifying beneficial shareholders and their related parties.

44

For further guidance about board responsibilities see Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), Principle 1, page 7-8.

Moldova Country Report – December 2011 Page 26 of 33

Supervisory practice

79. Compliance with regulatory requirements on internal control is actively supervised by the NBM, which monitors the independence and effectiveness of the internal audit as well as the competence of key executives within these functions. The NBM has access to all internal policies of banks and receives all internal reports. At the same time, the NBM meets regularly with the control functions of the bank, and assesses the effectiveness of internal control functions and the effectiveness of the management information system during its annual on-site assessments.

80. NBM closely monitors compliance by the banks with related parties disclosure and reporting requirements.

Bank practice

81. The Banks Reviewed have established separate internal audit departments responsible for monitoring adherence to internal rules and procedures, effectiveness of internal control systems, implementing an audit plan, issuing recommendations and verifying compliance with such recommendations. The internal audit departments in banks have a direct reporting line to the supervisory board, therefore ensuring its independence from the executive management of the bank. Our analysis has revealed that some of the banks have established a separate compliance function.

82. Banks generally develop and publish their organisational charts, which they regularly review. Most banks have reportedly drafted terms of reference for key functions, businesses and executive committees. Internal rules and regulations are filed with the NBM.

83. Banking regulations require that banks keep on file and regularly update detailed information on close relatives of supervisory boards’ members and senior managers, as well as information on bank shareholders and their beneficial owners. The Banks Reviewed reported to have separate internal policies for conflict of interest and related party transactions. Banks regularly report related party transactions to the NBM.

84. While the law does not require rotation of external auditor, some of the Banks Reviewed reported to practice rotation of their external auditors. Additionally, all external auditors must comply with experience requirements set and approved by the NBM.

Key weaknesses

Legal framework

85. Banking and company law and regulations require banks to have an audit commission, which is not a board committee but a separate body appointed by the general meeting of shareholders. Members of the audit commission must not be employees of the bank and they must all have at least one year of accounting experience. Banks' audit commissions therefore do not include any supervisory board or executive board members. Banking regulations vest the audit commission with a wide range of monitoring functions, including supervision of internal control systems, monitoring of the internal audit department and implementation of internal and external audit recommendations. The audit commission reports to the general meeting of shareholders and to the supervisory board.

Moldova Country Report – December 2011 Page 27 of 33

86. The practice of separate audit commission including "outsiders" in lieu of an audit committee comprised of (independent) supervisory board members needs to be carefully considered. The key question here is what could a person that it is not a board member add to the debate? 45 The discussion is open. First, we would argue that the audit commission should include only board members if the functions delegated to the commission are typical board functions. In this respect, the current Moldovan legislation assigns the final responsibility for the adequacy of the internal control systems, financial reporting and accounting policies belongs to the supervisory board. Secondly, it is essential that members, who sit on the audit commission and recommend specific actions to the supervisory board, then follow up such recommendation and vote it at the supervisory board, therefore reinforcing their position and the board’s “objective judgement”. Finally, this structure could create potential confidentiality and accountability issues, since the liability of the commission’s members may be even more lax than that of the supervisory board members. While the supervisory board may require external advice or expertise on specific issues – and it should be able to do so – it should not allow these outsiders to replace the board in making its decisions and recommendations.

87. While the audit commission may appear to have an important role on paper, in practice, it does not seem to add much value. It was reported that:

“The audit commission is most often a formal body comprising buddies or other relations of the shareholders. There are no sufficient resources to adequately staff such commissions and it is not entirely clear what value the commissions have.”

Best international practices recommend having an audit committee at the supervisory board level, comprising primarily independent supervisory board members with recent and relevant practical experience in the area of financial markets. At least one member, ideally the chair, should have specialist knowledge and experience in the application of accounting principles and internal control processes.46

88. The banking regulations do not require banks to set up a compliance function in charge of monitoring compliance risk.47 While some of the Banks Reviewed report to have established compliance departments, the law should provide some guidance on how this function should be organised. In particular, the law should provide for a broader scope of compliance function and avoid limiting its scope to anti-money laundering issues, as often is the case in the region. The law should also ensure independence of the compliance function, which may be achieved by first having the function submit reports to the

45

The arguments in favour of this approach are that non-board members would allow the audit committee to draw

from a larger pool of industry and accounting expertise and that it might give the audit committee greater independence. 46

EBA Guidelines on Internal Governance, 2011, page 28, see at: http://www.eba.europa.eu/cebs/media/Publications/Standards%20and%20Guidelines/2011/EBA-BS-2011-116-final-(EBA-Guidelines-on-Internal-Governance)-(2)_1.pdf 47

Compliance risk is defined as the current or prospective risk to earnings and capital arising from violations or non-compliance with laws, rules, regulations, agreements, prescribed practices or ethical standards) can lead to fines, damages and/or the voiding of contracts and can diminish a bank’s reputation. The compliance function should also verify that new products and new procedures comply with the current legal environment and any known forthcoming changes to legislation, regulations and supervisory requirements. See EBA Guidelines on Internal Governance (GL 44), page 43.

Moldova Country Report – December 2011 Page 28 of 33

supervisory board and second independent directors regularly meet with the head of the function.48

Supervisory practice

89. When asked about related party transactions, many interviewees were of the view that such transactions do not always occur under transparent conditions. The primary concern was the approach in identifying links among party transactions; it was reported to be rather formalistic and limited only to submitting long lists of documents to the supervisor.

90. The NBM appears to agree that despite detailed regulations for transparency of shareholders’ structures in banks, it is difficult to identify the real beneficial owners and other related parties. In 2008, one of the smaller Moldovan banks failed and was taken into administration by the NBM. Most of the sources agree that the main problem of the failed bank was weak governance and a network of transactions with related parties, as well as a week internal control system that failed to spot such issues and inadequate risk assessment structures within the bank.

Bank practice

91. As mentioned above, the role of the audit commission is not clearly understood and is not perceived as adding value. According to one of the interviewees:

“The law on joint stock companies requires banks to have audit commissions and we do it, otherwise I am not sure what purpose it serves.”

We have been informed that one bank, in the attempt to get a better outcome from the audit commission function, decided to hire an external auditor to perform its function in the next year, which is permitted by law. This reinforces the idea that the audit commission is perceived as a controlling structure for shareholders. The audit commission appears to be a reminiscence of the former revision commission, which served primarily as the shareholders' "watchdog".49 This is not what current best practice envisages as the role of the audit commission. The committee should be a supervisory board committee and is meant to increase efficiency and allow deeper focus in specific areas.50

92. Banks’ boards are generally staffed with CEOs of other companies. This might create conflicts of interests if CEOs’ respective companies are clients of the bank. Such potential becomes even more prominent when current regulations do not limit overall transactions exposure to affiliated persons.

48

See Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), Principle 9, page 24. 49

On this argument see also the EBRD/OECD “Policy Brief on Corporate Governance of Banks in Eurasia” at http://www.ebrd.com/pages/sector/legal/corporate/eurasia.shtml 50

"The audit committee typically is responsible for the financial reporting process; providing oversight of the bank’s internal and external auditors; approving, or recommending to the board or shareholders for their approval, the appointment, compensation and dismissal of external auditors; reviewing and approving the audit scope and frequency; receiving key audit reports; and ensuring that senior management is taking necessary corrective actions in a timely manner to address control weaknesses, non-compliance with policies, laws and regulations and other problems identified by auditors. In addition, the audit committee should oversee the establishment of accounting policies and practices by the bank", see Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), Principle 3, page 12-13.

Moldova Country Report – December 2011 Page 29 of 33

“A few largest banks in Moldova are run as cooperatives, this may have been working so far but this does not contribute to the development of the banks and will not be sustainable in the long term”.

“… Some banks give an impression of one big family…”

93. Notwithstanding the requirements set by the Law on Audit Activity51, external auditors appear to provide other than audit services, but banks do not seem to have policies to handle the provision of non-auditing services. Provision of non-audit services by the external auditor can significantly impair their independence (and might involve them auditing their own work). 52

Recommendations

Legal framework

1. The audit commission structure and composition should be re-considered with a view to understanding if the presence of outsiders makes the body effective. The legislator should also consider whether it is appropriate for the audit commission to become a proper board committee and include [a majority of] independent supervisory board directors. The audit commission as a whole should have recent and relevant practical experience in the area of financial markets and at least one member, ideally the chair, should have specialist knowledge and experience in the application of accounting principles and internal control processes.

2. The law should require banks to first have a compliance function and second include provisions ensuring the authority and independence of the compliance function with the bank.

Supervisory practice

3. The supervisor should review its approach in identifying related parties and conflicts of interests, focusing on achieving the main goal of such provisions and prevent abusive transactions with related parties and non-transparent governance structures within banks.

Bank practice

4. Banks should ensure the independence of the external auditor, and in particular have specific policies on provision of non-audit services by the external auditors.

51

According to the Law on Audit Activity, besides the audit, the same auditor cannot provide, within the same audited entity, for the same reporting period, services related to organization, restoration and maintenance of the accounting records; accounting expertise; tax planning and calculation of the liabilities to the budget, the preparation of tax returns; management assistance; assistance in management, reorganization and liquidation; carrying out the functions of the auditor/audit committee. 52

For further guidance see OECD Corporate Governance Principles (2004), p. 55, at: http://www.oecd.org/dataoecd/32/18/31557724.pdf

Moldova Country Report – December 2011 Page 30 of 33

5) Incentives and compensation

Key strengths

Bank practice

94. Although the law does not require banks to link compensation to prudent risk management and the supervisor does not closely monitor banks' remuneration practices, the compensation frameworks in Moldovan banks do not seem to create incentives for excessive risk taking. Responses to our questionnaires and interviews indicate that the variable part of executive compensation does not generally exceed 20% to 40% of the remuneration package.

Key weaknesses

Legal framework

95. National legislation does not provide any guidance on the principles of executive remuneration in banks and, in particular, the need to align compensation with prudent risk management.53 The supervisory board decides the remuneration of the senior executives; however its role concerning compensation policies for the entire bank is unclear. 54

Supervisory practice

96. The supervisor does not require banks to adopt remuneration policies. It appears that the supervisor’s concern is to ensure that executive remuneration is not excessive. Otherwise, the NBM does not seem to be aware of banks' remuneration practices and does not regularly monitor bank remuneration policies. The supervisor should keep abreast of banks’ compensation practices to ensure that banks link their remuneration practices to prudent risk management.

Bank practice

97. Banks do not seem to have in place remuneration policies setting guidelines for staff and executive remuneration and linking remuneration to bank or individual performance and prudential risk management. Currently, excessive risk taking may not be a primary concern for this market, but developing certain criteria for remuneration will contribute to shaping sound banking system.

98. Similarly, some banks reported that their CRO’s remuneration is based on the same criteria as those of senior management. This may influence the CROs’ decisions on risk management and jeopardise its objectivity. According to best international practice: "for employees in the risk and compliance function, remuneration should be determined

53

For further guidance on best practice regarding remuneration of senior executives see Compensation Principles and Standards Assessment Methodology, by Basel Committee on Banking Supervision, 2010 at: http://www.bis.org/publ/bcbs166.pdf; and FSB Principles for Sound Compensation Practices, 2009, at: http://www.financialstabilityboard.org/publications/r_090925c.pdf 54

"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 10, Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010).

Moldova Country Report – December 2011 Page 31 of 33

independently of other business areas; performance measures should be based principally on the achievement of the objectives of their functions."55

Recommendations

Supervisory practice/Bank practice

1. The supervisory authority should encourage banks to develop sound executive remuneration policies based on both bank and individual performance, as well as on prudent risk management. Additionally, the supervisor should pro-actively monitor remuneration policies and practices of banks. The NBM should be able to access the quantum and structure of key senior executives’ remuneration, including heads of control functions.

2. The remuneration of risk management staff should not be linked to bank’s performance. It should be determined independently of other business areas and based principally on the achievement of the objectives of their functions in order not to compromise their independent outlook on risk.

6) Transparency to the market and regulators

Key strengths

Legal framework

99. Company and banking regulations require detailed disclosures to the public of some corporate governance information, such as names of all shareholders holding more than 5% (including bank administrators and their affiliates), companies where the bank holds more than 25% and bank organisational structure. In relation to the supervisory board members, banks must publish information on their education, other current paid activities and experience for the previous 5 years.

100. Additionally, banks are required to keep on file detailed information about supervisory members’ holdings in other businesses, as well as those of their relatives, information about the administrators of such businesses and a list of persons related to supervisory board members. Such information must be regularly updated.

101. Listed banks are required to have a dedicated web-page that includes information on shareholders meetings, their rights and all documents discussed during such meetings.

Supervisory practice

102. The supervisor has extensive access to non-public information, including full access to banks' books and records and information on ownership structure. In addition to the regular reports from the control functions, the information filed each year with the NBM includes a corporate governance report, a report on ownership structure and a report on the effectiveness of internal controls.

55

Compensation Principles and Standards Assessment Methodology, Basel, 2010, Principle 3 - Standard 2, see at: http://www.bis.org/publ/bcbs166.pdf

Moldova Country Report – December 2011 Page 32 of 33

Bank practice

103. Banks generally disclose on their websites their financial statements and the composition of their supervisory boards, as well as information about board members’ education, previous experience and other current paid activities. Most reviewed banks also disclose names of the shareholders holding more than 5% with the bank. Others voluntarily disclose holdings of the supervisory board members even if they are less than 5%.

104. The analysis has revealed that all banks adopted codes of corporate governance. Some banks publish their codes on their websites, while others publish information in relation to the main responsibilities of bank governance bodies, including supervisory board. Others include a brief account of the work of the board and executive committees during previous year and their plans for the next year.

105. Furthermore, the review of banks websites and annual reports revealed that only few banks disclose names of the members in their audit commissions.

Key weaknesses

Legal framework

106. IFRS implementation by the credit institutions has been delayed; however the EBRD team was informed that from 1 January 2012 all credit institutions are required to prepare their accounts in accordance with IFRS.

Supervisory practice

107. Although the NBM has full access to all internal documents of the bank, it does not seem to require key information on risk and executives’ remuneration (e.g., report on risk as required by Basel II, Pillar III enabling a better assessment of their risk profile and their capital adequacy; a director remuneration report). 56

Bank practice

108. There is a clear perception that the shareholders’ structure of banks is not entirely transparent. The same refers to the relations among the shareholders and bank administrators.57

109. The review of banks websites and annual reports revealed that banks do not always publish the names and background of the members of their audit commissions.

110. The extent to which banks comply with their corporate governance codes and (for listed banks) with the National Corporate Governance Code is not disclosed.

56

For more information see: Basel Committee on Banking Supervision, Principles for enhancing corporate governance (2010), §§ 134-141. 57

See OECD Principles on corporate governance, 2004, p. 52-54, at: http://www.oecd.org/dataoecd/32/18/31557724.pdf

Moldova Country Report – December 2011 Page 33 of 33

Recommendations

Supervisory practice

1. Banking regulation should require banks to file with the NBM a report on risk along the lines required by Basel II, Pillar III enabling a better assessment of their risk profile and their capital adequacy.

Bank practice

2. Banks should publish names, qualification and experience of the audit commission members.

3. Banks should disclose full beneficial ownership for any party that directly or indirectly holds on its own or in connection with other affiliated parties more than the threshold established by law.