Financial Sector Assessment:A Handbook ance policy was bought.Insurance policies also have exclusion clauses that stipulate that insurance coverage will not be provided under specified circumstances.However. the exclusion clauses make insurance contracts difficult to understand and give rise to disputes.In some countries,those disputes result in long delays in settling claims,which accentuate the mistrust that clients experience toward the insurance companies. 9.1.7 Financial Safety Nets eposit insurance scheme for bank deposits or for policyholder and investor pro tion s re desi gned d capital clearly defned in are nown toand nde d by the public as already outlined in chapter 5.Even if those arrangements are specified in separate laws the relationship to the supervisory agency and the government,as well as the related coordination arrangements,should be transparent.The operation of lender-of-last. resort-both in normal and crisis times-is normally provided for in central bank laws. The scope of emergency lending.however.is often part of a larger legal and operational framework that pro wvides for c eration arrangements among agencies for crisis manage 9 ment and financial stability policie 9.2 Commercial Laws Key components of commercial laws that affect the sound functioning of financial institu tions and markets include laws that define the regime for formation of companies,corpo rate governance of both financial and nonfinancial firms,and consumer protection in the financial system.The scope of those components is outlined below. 9.2.1 Company Law Aregme for the creation and operation of companies sakey element of any system. providing f the fom and registration of differen types of compa nies- -including joint stock,limited liability,closed an open partnerships (limited and special),and other forms of corporate entities-should be in place.Those types of laws should deal with the operation of the company registrar,procedures for registering compa- nies.public access to the register.minimum capital requirements.procedures for the issue and transfer of shares,meetings of shareholders,rights and duties of shareholders,provi- sions for annual meetings,extraordinary meetings s,role of the board of directors,duties of directors,role of audit ors and audit ocedures,accounting and auditing requirements and penalties for infringements of the lav 9.2.2 Corporate Governance Governance of the financial sector has emerged as an important factor in financial stabil ity.Particularly in the transition economies where the legal and regulatory infrastructure is still in need of further strengthening,corporate governance has become recognized as 228
228 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 ance policy was bought. Insurance policies also have exclusion clauses that stipulate that insurance coverage will not be provided under specified circumstances. However, the exclusion clauses make insurance contracts difficult to understand and give rise to disputes. In some countries, those disputes result in long delays in settling claims, which accentuate the mistrust that clients experience toward the insurance companies. 9.1.7 Financial Safety Nets A deposit insurance scheme for bank deposits or for policyholder and investor protection schemes that are designed for insurance and capital markets should be explicitly and clearly defined in laws and regulations that are known to and understood by the public, as already outlined in chapter 5. Even if those arrangements are specified in separate laws, the relationship to the supervisory agency and the government, as well as the related coordination arrangements, should be transparent. The operation of lender-of-lastresort—both in normal and crisis times—is normally provided for in central bank laws. The scope of emergency lending, however, is often part of a larger legal and operational framework that provides for cooperation arrangements among agencies for crisis management and financial stability policies. 9.2 Commercial Laws Key components of commercial laws that affect the sound functioning of financial institutions and markets include laws that define the regime for formation of companies, corporate governance of both financial and nonfinancial firms, and consumer protection in the financial system. The scope of those components is outlined below. 9.2.1 Company Law A regime for the creation and operation of companies is a key element of any commercial system. Laws providing for the formation and registration of different types of companies—including joint stock, limited liability, closed and open partnerships (limited and special), and other forms of corporate entities—should be in place. Those types of laws should deal with the operation of the company registrar, procedures for registering companies, public access to the register, minimum capital requirements, procedures for the issue and transfer of shares, meetings of shareholders, rights and duties of shareholders, provisions for annual meetings, extraordinary meetings, role of the board of directors, duties of directors, role of auditors and audit procedures, accounting and auditing requirements, and penalties for infringements of the law. 9.2.2 Corporate Governance Governance of the financial sector has emerged as an important factor in financial stability. Particularly in the transition economies where the legal and regulatory infrastructure is still in need of further strengthening, corporate governance has become recognized as
Chapter 9:Assessing the Legal Infrastncture for Financial Sstems an important factor in establishing trust in the financial system and in ensuring that bank funds have been entrusted to competent and honest administrators.Poor governance erodes customer confidence in banks and financial institutions and deters potential cus- tomers from (a)placing deposits with the bank,(b)transferring savings to an investment fund,or (c)purchasing an insurance policy.Poor corporate governance also makes it more difficult for financial institutions to aise additional equity capital,especially from inves A strong corporate govemnance framework improves the quality of the enterprise sector and is an important issue in determining the quality of a country's investment cli mate.Well-governed companies are likely to be more creditworthy as bank borrowers.In addition,the equity shares of well-governed corporations can provide solid investments governance is associated with insufficient competition in the business sector,improve corporate governance practices can open the way for new entrants and increase competi- tion for customers and new markets. A corporate governance framework encompasses three primary areas: 1.Laws,regulations,and decrees that provide the legal framework for the commercial 9 sector encies responsible for the enforcement of legislation Common marketplace practices (or business culture)that,in some countries,are as important as legislation and institutions In the financial sector,it is important that the legal framework provide for (a)the ownership structure of banks,(b)appropriate fit and proper provisions for sharehold- ers and key administrators.(c)tran rency.and (d)strong regulatory oversight.The ulations for the oblig of di ors;director duties of care;procedures for the convening,operation,and termination of meetings;the relationship between management and owners:shareholder rights;audit responsibilities accounting practices;public access to the records of the company registry;ability of the shareholders to obtain copies of shareholder lists;disclosure of shareholdings by public sector officials;fiduciary obligations of members of boards;and presence of codes of cor porate conduct 9.2.3 Consumer Protection Consumers are an important stakeholder in the financial market.In fact,they are the reason for the existence of markets and,thus,they sustain markets.It is imperative that the legal framework provides for appropriate legal arrangements to safeguard the interest of consumers consumer protection in the financial system involves the protection of personal and credit information data;the right to security and safety in e-commerc e tran ons;the availability,access, and inexpen cost of services as remittar ces and the opening and maintaining of accounts;and an appropriate mecha nism to address grievances in the event of a dispute with a bank.Often,cost-effective 229
229 Chapter 9: Assessing the Legal Infrastructure for Financial Systems 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 an important factor in establishing trust in the financial system and in ensuring that bank depositors, insurance policyholders, and small shareholders have confidence that their funds have been entrusted to competent and honest administrators. Poor governance erodes customer confidence in banks and financial institutions and deters potential customers from (a) placing deposits with the bank, (b) transferring savings to an investment fund, or (c) purchasing an insurance policy. Poor corporate governance also makes it more difficult for financial institutions to raise additional equity capital, especially from investors outside the group of current shareholders. A strong corporate governance framework improves the quality of the enterprise sector and is an important issue in determining the quality of a country’s investment climate. Well-governed companies are likely to be more creditworthy as bank borrowers. In addition, the equity shares of well-governed corporations can provide solid investments for investment funds, pension funds, and insurance companies. Where weak corporate governance is associated with insufficient competition in the business sector, improved corporate governance practices can open the way for new entrants and increase competition for customers and new markets. A corporate governance framework encompasses three primary areas: 1. Laws, regulations, and decrees that provide the legal framework for the commercial sector 2. Regulatory agencies responsible for the enforcement of legislation 3. Common marketplace practices (or business culture) that, in some countries, are as important as legislation and institutions In the financial sector, it is important that the legal framework provide for (a) the ownership structure of banks, (b) appropriate fit and proper provisions for shareholders and key administrators, (c) transparency, and (d) strong regulatory oversight. The law also should provide detailed stipulations for the obligations of directors; directors’ duties of care; procedures for the convening, operation, and termination of meetings; the relationship between management and owners; shareholder rights; audit responsibilities; accounting practices; public access to the records of the company registry; ability of the shareholders to obtain copies of shareholder lists; disclosure of shareholdings by public sector officials; fiduciary obligations of members of boards; and presence of codes of corporate conduct. 9.2.3 Consumer Protection Consumers are an important stakeholder in the financial market. In fact, they are the reason for the existence of markets and, thus, they sustain markets. It is imperative that the legal framework provides for appropriate legal arrangements to safeguard the interest of consumers. Consumer protection in the financial system involves the protection of personal and credit information data; the right to security and safety in electronic and e-commerce transactions; the availability, access, and inexpensive cost of services such as remittances and the opening and maintaining of accounts; and an appropriate mechanism to address grievances in the event of a dispute with a bank. Often, cost-effective