The British actor Michael Caine was once quoted as saying: “Be like a duck. Calm on the surface, but always paddling like the dickens underneath.”
The statement released by the Capital Markets Authority (CMA) earlier this month regarding its enforcement actions against the management of National Bank of Kenya (NBK) #ticker:NBK was like Caine’s duck.
The calm announcement of sanctions against over half the former executive team at NBK was a culmination of months of frenetic multiple regulatory investigations that had taken place in the previous two and a half years.
But what happens to the directors of such an institution? In the NBK case, the CMA statement cast a glaring spotlight on the oversight failure of the bank’s board, more specifically the Audit Committee of the Board: “The misrepresentation of financial statements was occasioned by premature recognition of sale of assets amounting to Sh 800 million and under provisioning of loan amounts and wrongful recognition of interest income leading to the overstatement of profit in the respective periods.
The Bank had published unaudited financial statements reporting profits of Sh1.7 billion for the quarter ended June 30, 2015 and Sh2.2 billion for the quarter ended September 30, 2015 but subsequently reported a loss of Sh1.2 billion in its audited financial statements for the period ended December 31, 2015.”
Financial statements are never published before they are approved by the board, and a functional board never approves financial statements before they are received, torn apart, put together and ultimately recommended by the audit committee of the board.
We get a further glimpse from a Central Bank of Kenya (CBK) statement that sheds light on the inefficacious NBK Board.
“In keeping with its mandate as the banking sector regulator, the Central Bank of Kenya (CBK) initiated and caused the investigation of allegations of financial and other irregularities at the National Bank of Kenya (NBK) in 2015….Given that the preparatory work for the statutory external audit had begun in the last quarter of 2015, CBK instructed the external auditors to expand their scope and cover the alleged irregularities and other areas of concern.
“In light of the magnitude of the malpractices that were revealed to CBK, some immediate actions were taken. These included the statutory external audit, following which the final December 2015 accounts were correctly stated by inter alia ensuring that additional provisions of over Sh2 billion for non-performing loans were effected leading to a loss of Sh1.6 billion.”
Two committees of the board come into question with this telling statement. First, as aforementioned is the Board Audit Committee that is responsible for the financial statements that are published by the bank. Secondly is the Board Credit Committee whose specific responsibility, as provided by the CBK Prudential Guideline 3.5.2 (iii)(c)(g), is to assist the board with discharging its responsibility to review the quality of the banking institution’s loan portfolio and ensuring adequate provisions for bad and doubtful debts in compliance with the requirements of the prudential guidelines.
Were the NBK Board Committees asking the right questions or, more importantly, did they even know what questions to ask?
The CMA press release states: “CMA issues a regulatory caution to the board members who served on the NBK Board in the relevant period for ineffective oversight and failure to put in place a system of internal controls to ensure that the information going to the board for decision making was complete and accurate.”
It could have been worse as the CMA, under Section 25A (1)(c ) of its parent act, could have disqualified the directors from serving on the boards of any listed companies, recovered up to twice the amount of perceived benefit that a director may have received from the breach in question or levied financial penalties as may be prescribed.
In justifying its arrival at the mere caution, the CMA noted the mitigating actions that the NBK Board had taken, including reviewing the bank’s risk management and credit policies, escalation of noted fraudulent activities to the CBK’s Banking Fraud Investigation Unit, dismissal of implicated members of senior management, hiring of a new head of internal audit and, most importantly in my view, increasing the capacity of the NBK Board Audit Committee.
It is noteworthy that all these mitigating actions exemplify the NBK Board hurriedly shutting the stable door after the horse had bolted and the board got off fairly lightly with that rap on the knuckles from the CMA.
It’s not evident what the CBK will do with regards to the NBK board members, but their ability to pass the CBK Fit and Proper Test, that permits them to sit on any other financial institution board in future, is where the rubber will meet the road.