Measuring banking transparency in compliance with Basel II ...

Verslo ir teisės aktualijos / Current Issues of Business and Law ISSN 1822-9530 print / ISSN 2029-574X online

2011, 6(1), 90–110

doi:10.5200/1822-9530.2011.05

Measuring banking transparency in

compliance with Basel II requirements Ismail Ben Douissa Lecturer Financial Sciences Department Community College, Sharjah University PO BOX: 27272, Sharjah, United Arab Emirates E-mail: [email protected]; tel.: 00 97 156 607 5579 Received 23 February 2011; accepted 30 May 2011

Abstract

This paper analyzes a new bank transparency measure based on Basel II requirements, which is useful both for investors and for policy makers. It is the first study that displays a transparency measure based on four dimensions (completeness, opportunity, credibility and accessibility) of information. Empirically, we build a ‘bank transparency index’ using a sample of 69 banks across 7 emerging economies. Our results show that Turkish and Thai banks are at the top of transparent entities in the sample. However, North African banks are most likely to be less transparent. As regards corporate social responsibility reporting, we find that the majority of selected banks focus on philanthropic activities (the direct effect of corporate social responsibility). The indirect effect is rarely indicated. Finally, we conclude that the major failure of emerging countries in the field of banking transparency affects essentially not the quantity of the revealed information, but rather its quality. Keywords: Basel II, transparency, information, corporate governance, corporate social responsibility.

Bankų veiklos skaidrumo matavimas

laikantis Bazelio II nustatytų reikalavimų Anotacija

Šiame straipsnyje analizuojama nauja bankų veiklos skaidrumo matavimo priemonė, sukurta laikantis Bazelio II nustatytų reikalavimų ir naudinga ir investuotojams, ir už politikos formavimą atsakingoms institucijoms. Tai yra pirmasis tyrimas, kuris pateikia keturiais informacijos matmenimis (visapusiškumas, galimybės, patikimumas ir prieinamumas) grindžiamą skaidrumo matavimo būdą. Remiantis empiriniais duomenimis, nustatomas 90

http://www.vta.ttvam.eu

Verslo ir teisės aktualijos / Current Issues of Business and Law, 2011, 6(1), 90–110

„bankų veiklos skaidrumo indeksas“, apimantis 69 bankus 7 besivystančiose šalyse. Tyrimo rezultatai rodo, kad Turkijos ir Tailando bankai nagrinėjamų įmonių grupėje yra vieni iš skaidriausių. Labiausiai tikėtina, kad mažiau skaidrūs yra Šiaurės Afrikos šalių bankai. Tyrimas rodo, kad dauguma pasirinktų bankų, įmonių socialinės atsakomybės ataskaitų atžvilgiu, didžiausią dėmesį skiria filantropinei veiklai (tiesioginė įmonių socialinės atsakomybės įtaka). Netiesioginė įtaka nagrinėjama retai. Straipsnio autorius daro išvadą, kad besivystančių šalių nesėkmės bankų veiklos skaidrumo užtikrinimo srityje iš esmės turi įtakos ne atskleistos informacijos kiekiui, o jos kokybei. Reikšminiai žodžiai: Bazelis II, skaidrumas, informacija, įmonių valdymas, įmonių socialinė atsakomybė.

Introduction In the last quarter of the previous century, the banking regulation framework underwent structural changes. In fact, the failure of the German private bank Herstatt Bank in 1974 was the origin of this evolution. Thousands of depositors of the bank lost large amounts of funds due to its policy of speculation in currencies. In connection with this crisis, the countries of G10+* formed the Basel Committee in 1974 to ameliorate the stability of the banking system. Its role is to recommend new banking practices and to propose minimum standards. Until now, the Basel I agreements of 1988 constitute the most important task accomplished by the Committee. They represent a major stage for the international banking system by introducing, for the first time, a common rule for the minimum capital needed for a bank. With the development of banking management techniques, the limitations of Basel I became more and more visible. In fact, this agreement did not take into account the quality of loans portfolio, the operational risk as well as the risk management quality of a bank. These findings led the Committee of Basel to start building the Basel II agreements in 1999. After 5 years of work, the members of the Basel Committee approved the agreements in June 2004. These agreements are structured into three pillars as follows: minimum capital requirements, supervisory review and market discipline. The Basel agreement under analysis in this paper aims at giving motivations to banks ‘to manage their risks more carefully’. This paper focuses on the third pillar of the Basel II agreements. A consultative document of the Basel II Committee on Banking Supervision (2003) sta* United States, Canada, Japan, England, Netherlands, Germany, France, Belgium, Luxebourg, Italy, Switzerland, Norway, Sweden.

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I. Ben Douissa Measuring banking transparency in compliance with Basel II requirements

tes that this pillar ensures the disclosure of information showing the adequacy of the capital: capital structure, quality of assets, processes and risk management methods, the history of key variables. On the one hand, this pillar guarantees net visibility of the risk-taking policy of the bank. On the other hand, investors, depositors and creditors would benefit from it; they could analyze the actual financial situation of the bank, which would influence their risk taking strategies. As a result, banks would adjust their risk levels according to their minimum capital requirements. Otherwise, banks would face sanctions (sometimes heavy) from the market. Moreover, our interest in banking transparency finds its origin in the following fact: several banks which seemed to be competitive see themselves later being in trouble, because information was hidden. The majority of banks in trouble are rescued by the central bank in order to avoid the domino effect in the entire banking system. For this reason, the names of banks in trouble are in general not announced to the public. As an example, Lehman Brothers was an investment bank which collapsed in the United States in 2008 partly due to the lack of transparency. Transparency is defined as ‘the widespread availability of relevant, reliable information about the periodic performance, financial position, investment opportunities, governance, value, and risk of publicly traded firms’ (Bushman and Smith, 2003). Therefore, developing a measure of banking transparency represents a big challenge for the following reasons: • The classical difficulty in measuring the transparency because it is very complicated to surround all its elements. • The information disclosed by banks is specific (demand deposits, saving deposits, documentary credits, guarantees, etc.) and differs from that provided by firms. Moreover, few studies approached the subject of banking transpa rency, which makes the task even more difficult. The main goals of this paper are to build a new measure of bank transparency based on four dimensions of information and to rank banks belonging to emergent countries accordingly. The methodology applied in this research consists in developing a transparency index based on 43 sub-indexes. Each group of indexes represents a particular dimension of information. Binary notation is used to grade the sub-indexes. Firstly, we will analyze the previous studies which focused on firm transparency and then particularly bank transparency. Secondly, we will present the methodology that deals in detail with the composite index of bank transparency. Finally, we will display major empirical findings. 92


1. Theoretical background of transparency 1.1. Recent studies on firm transparency Literature abounds in research on problems of transparency; however, the majority of these studies have been interested in firms in general. We will develop in the following sections of the paper the conceptual framework of two most important studies providing an objective quantification of firm transparency. These studies will act as a theoretical basis in our analysis. Firstly, La Porta et al. (1998) introduce the CIFAR (Center for International Financial Analysis Research) index as an indicative element of firm transparency across the studied countries. Secondly, the transparency classifications advanced by Standard & Poor’s (SP) in a study elaborated in Europe (Patel et al., 2003) provide an evaluation of disclosure practices of companies in various countries around the world. SP recognized the universal lack of information comparability and launched an important study on the biggest and the most liquid companies around the globe to complete its range of products of corporate governance. Transparency and information disclosure are estimated by analyzing firms’ annual reports (in the English language as well as in a local language) for the inclusion of 98 information elements (‘the attributes’). These attributes are then grouped in three sub-categories: • Property structure and relationships with investors (28 attributes); • Financial transparency and disclosure of information (35 attributes); • Board of directors’ structure and management (35 attributes). This study was improved by another one conducted on Russian companies in 2009 (Stepanov et al., 2009). In fact, the analysis accounts for information included in three major sources of public information: annual reports, webbased disclosures, and public regulatory reporting.�� The �� checklist method consists of 110 items related to the following three blocks: ownership structure and shareholder rights, financial and operational information, and board and management structure and process. Furthermore, Bushman et al. (2004) presents a conceptual framework to estimate firm transparency at the national level. It consists of three channels: the financial statements of a firm, holding of private information and publication of information. In spite of the existence of abundant literature on firm transparency, we underline the scarcity of studies dealing with banking transparency. Indeed, 93


the elements to be revealed by a bank are specific (deposits, loans, etc.). We will present in the following sections of the article the key studies on this subject. 1.2. Theoretical background of bank transparency Baumann and Nier (2003) have presented three indexes of information disclosure for banks: the first one indicates that a bank publicly traded on the NYSE, NASDAQ or AMEX has to align itself with the binding rules of information disclosure required by these markets, which guarantees (according to the authors) its transparency. Consequently, the depositors will demand a return relatively lower than in the case when the bank is traded outside these markets. The second index is based on bank rating. Indeed, investors should have more information on a bank if it is estimated by a rating agency which is recognized internationally (Standard and Poor’s, Moody’s or Fitch). The third measure of disclosure was built on the basis of the information contained in financial statements. This index provides information on 17 ca tegories of information revealed in the annual reports published by a bank as represented in the database “BankScope”. All the categories are connected to one or several dimensions of the bank risk profile (interest rate risk, credit risk, liquidity risk and market risk). Each category is represented by one sub-index which measures the details level of the information which banks publish in their annual reports. This measure was also used by Baumann and Nier (2006) and Nier (2005) as a proxy for bank transparency. The first two indexes are indirect measures of the quantity of information available to investors. The advantage of the third index is that it is a direct measure of the quantity of information revealed to the market. However, it does not take into account the totality of information dimensions (completeness, periodicity, opportunity and accessibility). Furthermore, it ignores the non financial information disclosed by the bank. Furthermore, Tadesse (2006) has developed three transparency variables: quality of regulated disclosure, acquiring private information, and information disclosure. The breakdown of bank transparency measurements, according to Tadesse (2006), is based on the database of Barth et al. (2001). Within our study framework, we retain the index proposed by Baumann and Nier (2004), which consists in disclosure, by a bank, of certain key elements of financial statements. We will later discuss the reasons of this choice as well as those of the possible adjustments to be made to adapt this index to the recent recommendations of the Basel Committee. We will discuss in the following sections the index set-up methodology and its implementation. 94


2. Research methodology The main objective of the third pillar of Basel II agreements is to increase bank transparency so that the market discipline can work suitably and, consequently, can ensure the stability of the banking system. Within our study framework, we will try to develop a measure of bank transparency. This measure would be useful both for investors and for national or international authorities. Indeed, the investors or the authorities can compare the transparency levels of several banks of the same country. Furthermore, it is possible to detect the banks which are latecomers in this domain. Therefore, every bank would be incited to improve the explanatory elements of transparency in order to improve its rank. The present study is the first known study to use elements revealed by a bank according to the recommendations of the third pillar of the Basel II agreements in order to analyze its transparency. On the one hand, previous studies simply used the summary scores of Standard and Poor’s published by Patel et al. (2003) (for example, Durnev and Kim, 2002; Khanna et al., 2004) and their samples consist exclusively of non-banking firms. On the other hand, Baumann and Nier’s paper of 2003, which focused on banking transparency, was not prepared in compliance with the recommendations of Basel II. Moreover, we notice that the previous studies on the subject simplified their measures by assessing the degree of transparency by the volume of the revealed information. However, according to Nelson (2001) an adequate measure consists of the following four dimensions: • The completeness of information. • The accessibility of information. • The opportunity of information. • The investors’ right of appeal. Furthermore, Baumann and Nier (2003) recognize that their measure of disclosure could be improved by integrating the periodicity and the opportunity of the communicated information. Thus, we suggest developing a measure of banking transparency which consists of four dimensions of information (as discussed in detail above) with some adjustments. Indeed, we will develop a composite index of banking transparency, which represents the aggregate of four intermediate indexes. Each index represents one of the four dimensions of information.

95


2.1. Dimensional indexes of bank transparency We intend to build a multidimensional measure of transparency, and its first dimension (completeness of information) is based on the disclosure index (‘DISC’) developed by Baumann and Nier (2003). We retain, in addition to other previously discussed dimensions, the opportunity and accessibility of information. Indeed, given the complexity of the task of measuring the investors’ right of appeal, this dimension will be excluded from the multidimensional measure. We suggest replacing it by the credibility of information. Each dimension would be represented by an intermediate index and afterward, the four indexes would form a composite index of transparency. 2.1.1. Index of information completeness We suggest expanding the DISC index proposed by Baumann and Nier (2003) by adding other elements to take into account the entire information publi shed by banks in their annual reports. Indeed, the information contained in financial statements (balance sheet, income statement, cash flow statement) is of a financial and a quantitative nature. This information is not enough for constituting an accurate true-to-life image of a firm. Consequently, it appears relevant to take into account, when calculating the intermediate index, the elements of non-financial information. It consists of the quality of risk management, bank governance, business strategy of a company, the quality of management, and social and environmental performance (Perrini and Tencati, 2006). These elements allow different stakeholders to better understand the overall performance of the company, its strategy as well as its growth prospects. According to Stepanov et al. (2009) and Bushman et al. (2004), it seems relevant to integrate 7 additional sub-indexes (from S18 to S24, see Table 1) in the intermediate index corresponding to the first dimension of information (completeness). Furthermore, we propose an additional sub-index which provides information about related lending. The literature has generated a debate between proponents and opponents of related lending. The opponents advance a pessimistic point of view; the fact that related loans allow major shareholders to steal depositors’ resources and minority shareholders’ interests. This point of view was expressed for the first time by Akerlof and Romer (1993). La Porta et al. (2002) have proved that the pessimistic point of view mainly pertains to developing countries. For that reason, we will integrate the related loans as an interesting element which indicates a bank’s transparency, because our sample consists of the banks operating in developing countries. 96


Moreover, the index developed by Baumann and Nier (2003) reflects the following types of risk revealed by banks: the interest rate risk, the credit risk, the liquidity risk and the market risk. However, it does not take into consideration the operational risk. This risk was officially defined and taken into account in the consultative document of the Basel II Committee on Banking Supervision (2008) as the risk of losses which can result from inadequate or non-applied internal procedures from persons, from systems or from external events. Hence, the Committee retained seven events of the operational risk. We are convinced that integrating the elements indicating the operational risk will enhance the quality of the transparency measure. Consequently, we integrate 7 additional sub-indexes to inform about these events. In addition, it seems to us relevant to integrate in the proposed transparency measure the estimations of predictable information informing the investors about the future perspectives of a bank. Indeed, we believe that a bank which reveals reliable forecasts of the key variables of its activities is more transparent than the one which does not. Finally, more and more interest is being given by academicians and practitioners to business ethics and to the activities of social and environmental responsibility (CSR) in the global economy (Blair, 2008). Disclosure of this non-financial information is defined as ‘the process of announcing the social and environmental effects of economic actions undertaken by firms on the stakeholders particularly and the community in general’ (Gray et al., 1996). Compared to others sectors, such as chemicals, textile industry, etc, the banking sector has a less profound social and environmental impact. Jeucken and Bouma (1999), Simpson and Kohers (2002), and Mazurkiewicz (2007) differentiate two types of social and environmental effects of the banking activity: an internal impact and an external one. The internal impact (‘direct CSR’) is related to the banking activity process, while the external impact (‘indirect CSR’) is linked to its products. Moreover, we suggest including the above mentioned elements in the construction of the intermediate index of information completeness. Consequently, the addition of 20 new sub-indexes in the intermediate index brings the total number of sub-indexes to 37. The grading details of the 20 sub-indexes are developed as follows. We follow the measurements adopted by Baumann and Nier (2004) to calibrate the sub-indexes. Indeed, for all sub-indexes, 1 is assigned if the corresponding element exists in the bank annual report and 0 – in other cases, except S6, S13, S18, S36 and S37.

97


By aggregating the 37 sub-indexes, we build the intermediate index of information completeness, which will be referred to as ‘MRDISC’ (‘multi risk disclosure’). The intermediate index is calculated as follows (as illustrated by Baumann and Nier, 2003): 1 MRDISCit = ( FREit + NFREit ) , (1) 43 where FREit is the financial items revealed by the bank i over the period t. NFREit is the non financial items revealed by the bank i over the period t

MRDISCit =

37  1  17  ∑ si + ∑ si  ,  43  i =1 i =18  

MRDISCit =

1 43

37

∑ skit ,

(2) (3)

k =1

where MRDISCit is the intermediate index of information completeness of the bank i during the period t. We divide by 43, because the maximum scores of S6, S13, S18, S36 and S37 are respectively equal to 2, 3, 2, 2 and 2. The 37 sub-indexes are presented in detail in the following table: Table 1. Completeness of information Information FINANCIAL INFO DISC*

Sub-indexes

Categories

From S1 to S17

NON FINANCIAL INFO

Bank governance

S18: Subsidiaries

Identity of subsidiaries and the share held by the bank in the capital of each subsidiary.

S19: Shareholders ranking

Property structure.

S20: Major shareholders

Identity of major shareholders.

S22: Board of directors

List of members of the board of directors. Remuneration of members of the board of directors and executive directors.

S24: Stock options

Share held by the top management and other employees in the capital of the bank.

S25: Related lending

Loans given to parties linked to the bank.

S21: Management

S23: Remuneration policy

98

List of the executive directors.


The end of Table 1 Information Operational risk

Sub-indexes S26: Internal fraud

Losses associated with employees’ corruption.

S27: External fraud

Losses associated with phishing**.

S28: E mployment and safety practices

Trade unions’ annual report.

S29: Commercial practices

S31: Dysfunctions of the activity and the systems

Aggressive sales or whitening of money. Losses associated with terrorism or disasters. Losses associated with information systems breakdown.

S32: Processes management

Losses associated to execution mistakes.

S33: Perspectives

Segments of bank development.

S30: Tangible assets damages

Forecasts

Corporate Social Responsibility

Categories

S34: Expected growth

Expected growth rate.

S35: Dividends distribution

Dividends distribution policy.

S36: CSR direct

The nature of undertaken activities and the proportion of total assets allocated to these activities. The nature of undertaken activities and quantitative information regarding rejected loans to corporations.

S37: CSR indirect

* See Baumann and Nier, 2003. ** In the field of computer security, phishing is the criminally fraudulent process of attempting to acquire sensitive information, such as usernames, passwords and credit card details, by masquerading as a trustworthy entity in an electronic communication.

2.1.2. Index of information opportunity We think that the opportunity of information is positively correlated to the frequency of its disclosure. Specifically, a good opportunity of information is guaranteed by the existence of its periodic updating and, hence the importance of frequency of interim report publication. That is why we suggest introducing the sub-index ‘Frequency of interim reports’. Consequently, the intermediate index of information opportunity is built as follows: Table 2. Information opportunity Information Information opportunity

Sub-indexes S38: Frequency of interim reports

Categories

Biannual or quarterly reports.

99


The intermediate index of information opportunity is referred to as ‘OPPORT’ and calculated as follows:

OPPORTit =

1 s , 2 38it

(4)

where OPPORTit is the intermediate index of the opportunity of information of the bank i during the period t. 2 is assigned to S38 if the bank publishes quarterly reports, 1 is assigned if it publishes only biannual reports and 0 – in other cases. Finally, division by 2 in the intermediate index is related to the maximum score of this sub-index. 2.1.3. Index of information credibility We introduce three sub indexes: audit, accounting standards and accounts adjusted by inflation. Indeed, Bushman et al. (2004) support the fact that the variable ‘Audit’ is a measure of the reliability of financial disclosures. We distinguish the most prestigious four auditing firms in the world named the ‘Big Four’ or the ‘Fat Four’: • Deloitte, formerly Deloitte Touche Tohmatsu (DTT); • Ernst and Young (EY); • KPMG; • PricewaterhouseCoopers (PwC). Consequently, we distinguish the banks audited by a ‘Big Four’ auditing company from the banks audited by other auditing companies. The introduction of the sub-index ‘Audit’ is supported by the following statements: • The importance of the audit function as a guarantee of the credibility of the publications made by the bank; • We consider that the bank audited by a ‘Big Four’ company would be more transparent compared to a bank which is audited by another firm. Furthermore, the sub-index ’Accounting standards’ informs about the accounting practices used by a bank. Thus, we distinguish two types of standards applied by banks: local standards (‘local GAAP’ (Local Generalized Accepted Accounting Principles)) and international standards (‘IFRS’ (International Financial Reporting Standards)). According to Patel et al. (2003), we support the idea that a bank applying IFRS standards is more transparent than a bank adopting local standards. In fact, the degree of data comparability is more relevant in the first case. Finally, we introduce the sub index ‘Accounts adjusted by inflation’ to distinguish the banks which publish their financial statements adjusted by infla100


tion. Indeed, this type of data publication reflects the real image of the bank by taking into account inflation. Consequently, we consider that a bank which publishes its annual accounts adjusted by inflation is more transparent than a bank which does not. Our suggestion is supported by the study of Patel et al. (2003), which shows that the adjustment by inflation is a criterion of firm transparency. The intermediate index of information credibility is given in detail below: Table 3. Information credibility Information Information credibility

Sub- indexes

Categories

S39: Audit

Auditing company identity.

S40: Accounting standards

Applied accounting standards (IFRS or Local GAAP).

S41: Accounts adjusted by inflation

Annual financial statements adjusted by inflation.

The above mentioned intermediate index is built by aggregating the information of three sub–indexes, namely, ‘Audit’, ‘Accounting standards’ and ‘Accounts adjusted by inflation’. It is calculated as follows:

CREDit =

1 4

41

∑

k = 39

skit ,

(5)

where CREDit is the intermediate index of information credibility of the bank i during the period t. We assign 0 to S39 if the bank does not communicate the identity of the company which has audited its accounts, 1 – if the bank is audited by a company which is not a member of the ‘Big Four’. Finally, 2 is assigned if the bank is audited by the ‘Big Four’. We assign 1 to S40 if the bank applies the IFRS standards and 0 in other cases. We assign 1 to S41 if the bank publishes its annual accounts adjusted by inflation and 0 in other cases. Finally, the division by 4 in the intermediate index is due to the maximum score of S39, which is equal to 2. 2.1.4. Index of information accessibility To measure the accessibility of information, we distinguish the information revealed to the public and private information. The first type of information is contained in the financial statements published by a bank in its annual reports. Private information represents any element not revealed to the public. Access to this type of information is reserved for a limited group of information users, 101


such as major shareholders, financial analysts and rating agencies. Indeed, major shareholders obtain private information according to their decision-making powers in the board of directors. Furthermore, rating agencies possess private information about the companies which they rate; firms are motivated to be rated by these agencies with the aim of being able to reach international financial markets. This constitutes the second distribution channel of information. We consider two sub-indexes which measure information accessibility according to both chosen channels as follows: 1. Web access: we suggest measuring information accessibility using the first channel (annual reports) by means of inclusion or non-inclusion of these reports by a bank in its website. Our measure finds its origin in the fact that the publication of the bank’s annual report in at least one of national daily newspapers is compulsory. However, the introduction of these reports in the bank’s website is voluntary. 2. Rating: we suggest measuring information accessibility using the second channel (rating agencies) by means of distinguishing the banks rated by international agencies. This requires an analysis of the classification of rating agencies. Agencies could be divided into three categories: • National rating agencies; • Regional rating agencies; • International rating agencies. We believe that a bank rated by an international agency is more transparent than a bank rated by a regional agency or a bank rated by a national agency. The intermediate index of information accessibility is presented in detail as follows: Table 4. Information accessibility Information

Sub-indexes

Categories

Information accessibility

S42 : Web access S43 : Rate

Availability of annual reports on the bank’s website. Rating agency classification.

The above mentioned intermediate index is built by aggregating the information of both sub-indexes of ‘Web access’ and ‘Rate’. It is calculated as follows:

ACCESSit =

1 3

43

∑

k = 42

skit ,

(6)

where ACCESSit is the intermediate index of information accessibility of the bank i during the period t. We assign 1 if the bank publishes its annual reports on its website and 0 in all other cases. We assign 2 if the bank is rated by an 102


international agency; 1 is assigned if the bank is rated by a regional agency and 0 in all other cases. Finally, division by 3 in the intermediate index is due to the maximum score of S43, which is equal to 2. 2.2. Composite index of bank transparency We present in what follows the composite index of bank transparency called ‘TRANS’: 4

∑ S jit

TRANSit =

j =1

N

,

(7)

where TRANSit is the composite index of transparency of the bank i during the period t, N is the number of the dimensions of information, which is equal to 4, S jit is the intermediate index of the dimension j of the bank i during the period t,

TRANSit =

MRDISCit + OPPORTit + CREDit + ACCESSit , N

TRANSit =

1 43

37

∑ skit +

k =1

1 1 s38it + 2 4 N

41

∑

k = 39

skit +

1 3

43

∑

k = 42

(8)

skit

.

(9)

In developing the composite index, we consider that four dimensions of information (each measured by the corresponding intermediate index) possess the same degree of importance to explain transparency. We have introduced intermediate indexes without weights in the construction of the composite index in order to eliminate the subjectivity problem (Hodgdon et al., 2008). 3. Case analysis The banking data used in our study are collected from the BankScope database. The chosen sample consists of 69 banks operating in emerging countries. Moreover, the financial and non-financial data relating to our sample were collected in 2006. The objective of our date choice has been to study the levels of bank transparency before the application of the Basel II agreements in the 103


emerging countries. Consequently, we analyze the voluntary part of transparency. The choice of year 2006 is supported by the fact that the application of the Basel II agreements in the studied countries will be compulsory starting from 2007. The criteria of our sample choice are listed below: Table 5. Selection methodology of the sample Criterion

Criterion detail

Justification of the criterion choice

Country

Tunisia, Morocco, Lebanon, Malaysia, Thailand, Turkey and Egypt

Emergent countries* in which Basel II agreements had not been applied until 2006.

Specialization

Commercial and investment banks

Banks collecting deposits and facing different banking risks.

Financial statements consolidation

Consolidated financial statements

Consolidated financial statements inform about the characteristics of the bank’s subsidiaries.

Listed banks

Publicly traded banks

Availability of information on bank governance. This criterion enables us to study the eventual correlation between transparency and firm value.

* The emergent countries whose GDP is dominated by revenues from natural resources are excluded from ours sample.

The studied banks are presented in detail according to the emergent countries as follows: Table 6. Percentage of the sample in the national banking system (source: BankScope-treated data)

Country

Number of studied banks

Percentage of the sample in the national banking system*

Tunisia

12

98.93%

Morocco

5

91.67%

Lebanon

6

57.68%

Malaysia

4

24.85%

Thailand

12

86.28%

Turkey

15

90.81%

Egypt

15

33.86%

Total

69

* The combined capitalization of the studied banks in the same country divided by the capitalization of all commercial and investment banks in the country.

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4. Findings Our results present the composite transparency index of 69 banks. These banks are distributed according to their countries. The results show an important disparity among the dimensions of information, the banks under consideration as well as among countries. 4.1. Comparative analysis by the dimension of information We previously explained that transparency is a complex concept with various dimensions of the revealed information. Indeed, the detailed study of each dimension guides us towards the failing compartment of transparency. Consequently, we could target the actions to be done in order to reach the results expected by the Basel Committee. We observe that the relative decline of banking transparency indexes in several countries of the sample is due to the intermediate indexes of opportunity and credibility. Indeed, the average of both of these intermediate indexes in the entire sample is respectively equal to 34.76 % and 42.26 %. This explains that the lack of banking transparency in emerging countries is due to the qualitative element of information and not the quantitative one. On the one hand, banks do not reveal information on time; on the other hand, the revealed information is not reliable. However, this report does not mean that the other two intermediate indexes are satisfactory. 59.82 % and 65.07 % are respectively the average rates for the intermediate indexes of completeness and the accessibility: these levels should be improved. Moreover, the index of information completeness consists of two elements: financial and non-financial information. Results show that the MRDISC index is distinctly lower than the DISC index in all studied countries, except for Thailand. In fact, we have improved the DISC index by introducing non-financial information elements. Consequently, we have detected a decline in the transparency of the studied banks with regards to the quantity of the disclosed information. This statement indicates that the majority of the banks under analysis show a major failure in revealing non-financial information, such as governance, operational risk, management strategy and the activities of social and environmental responsibility. 4.2. Comparative analysis by bank We have detected a considerable disparity among the studied banks as regards their transparency indexes. Our study shows that the least transparent bank is 105


the ‘Société Arabe Internationale de Banque’ in Egypt with a transparency index equal to 14.57 %. This means that this bank is far from being in compliance with the recommendations of the Basel Committee. On the other hand, the most transparent bank is the Audi SAL bank in Lebanon, which possesses a transparency index equal to 85.03 %. Moreover, a wide disparity exists also among banks of the same country. For example, in Lebanon, the Bank of Beirut SAL has a transparency index of 39.29% which is the lowest at the country level. On the other hand, the transparency index of the Audi SAL bank is 85.03 %. This statement emphasizes the voluntary action of that bank to meet international banking standards. 4.3. Comparative analysis by country The results show that there is a disparity between the studied countries in our sample. Indeed, the countries are classified in the decreasing order according to their national average of the banking transparency as follows: Table 7. National average of banking transparency Rank

Country

Number of studied banks

National average of the banking transparency

1

Turkey

15

63,24%

2

Thailand

12

61,63%

3

Lebanon

6

59,80%

4

Malaysia

4

51,91%

5

Morocco

5

51,32%

6

Tunisia

12

35,30%

7

Egypt

15

30,15%

Total

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This classification made in 2006 shows well the lack of banking transparency in the countries of North Africa. Indeed, this statement is due to several factors: micro and macroeconomic, cultural and political factors. Turkey and Thailand appear on the top of the list and seem to be the countries most prepared to apply the Basel II agreements among those of the sample. Indeed, large effort has been undertaken in these countries regarding banking transparency; for example, Turkey is trying hard to be coherent with European standards at the political, economic, and financial level with the aim of acceding to the

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European Union. On the other hand, Thailand is a country which attracts important foreign investments in particular in the banking domain. Accordingly, banking transparency is guaranteed.

Conclusions In response to the financial scandals which have shaken the whole world, in particular the financial sector, the Basel Committee adopted has more stringent standards of transparency. Indeed, the Basel II agreements have been applied in several developed countries since 2006, whereas the majority of emerging countries have not found the way yet. This paper has attempted to answer the following question: What are the emerging countries’ ranks regarding transparency of their banks? We have showed that until 2006, the studied emerging countries had applied on average only 50.48 % of the recommendations of the Basel Committee regarding banking transparency. Furthermore, our study has revealed disparities between countries as well as between the dimensions of the revealed information. In fact, Turkey is twice as transparent as Egypt. On the other hand, a detailed analysis of various dimensions of the information has showed that the indexes of banking transparency in emerging countries are pulled downward by relatively low intermediate indexes of the opportunity and credibility of information. We have concluded that the major failure of the emerging countries in banking transparency is not linked primarily with the quantity of the revealed information, but rather with its quality. Hence, information is not revealed on time, and its reliability is subject to criticism too. The quantitative part of the information is partly affected by non-financial information opacity. As a result, the majority of studied banks show a weak interest in the publication of this type of information. In further research, we intend to develop the sub-indexes related to the activities of social and environmental responsibility undertaken by banks. The direct impact of CSR could be measured using the Global Reporting Initiative (GRI). The indirect one could be proxied by the Equator principles. These principles are taken into consideration in the financing decision-making process in all industrial projects of the value of USD 10 million or more. However, these principles are most likely adopted by universal banks due to their important size. As a result, they exclude small banks. These references in measuring the

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performance of social and environmental responsibility were newly and deliberately adopted by international banks to emphasize their activities of CSR. Furthermore, we seek to study the determinants of bank transparency. In the light of the results we have obtained, we can clearly detect a possible association between bank transparency and bank governance. For example, the lack of transparency of Banque de l’Habitat (TRANS = 18.80 %) in Tunisia may be explained, in our opinion, by several reasons. The first reason is the property structure of this bank; the Tunisian Government is the major shareholder with 32.62 % of the capital, the rest of the bank capital is distributed between two foreign investment funds, a Tunisian oil company and a foreign bank as well as other private investors. Indeed, the capital of Banque de l’Habitat’ is mainly concentrated in the hands of three shareholders. Consequently, the bank is not incited to reveal the information publicly. The second reason of this lack of transparency is that Banque de l’Habitat is publicly traded on the local market; in 2006, its requirements of transparency were sharply below the recommendations of Basel Committee. Moreover, after analyzing the property structure of the bank Audi SAL, we notice that the shareholding is distributed between a foreign bank, a number of families from the Middle East and individual investors each possessing less than 5 % of the capital. Consequently, we think that this dilution of the bank’s capital explains partially its high transparency compared to the other banks of the sample. Furthermore, the shares of the bank Audi SAL are traded on the London Stock Exchange and on the Beirut Stock Exchange. Indeed, the security trading of the bank on the London Stock Exchange stands for a guarantee of transparency, because the conditions of access to this market are relatively binding. References Akerlof, G.; Romer, P. (1993). Looting: The Economic Underworld of Bankruptcy for Profit. Brookings Papers on Economic Activity. Washington: The Brookings Institution. Barth, J. R.; Caprio, G.; Levine, R. (2001). The regulation and supervision of banks around the world: A new database. In R.E. Litan; R. Herring (Eds.), Brookings-Wharton Papers on Financial Services (pp.183-240). Washington, DC: Brookings Institution Press. Basel Committee on Banking Supervision. (2003). Public disclosure by banks: Results of the 2001 disclosure survey. Consultative Document. Bank for International Settlements. Basel Committee on Banking Supervision. (2008). Proposed revisions to the Basel II market risk framework. Consultative Document. Bank for International Settlements.

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Information about the author Ismail Ben Douissa is a Finance Lecturer and Coordinator at the Administrative and Financial Sciences Department of the Community College, University of Sharjah, UAE. His research and teaching covers bank regulation, CSR and transparency.

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