The Impact of Corporate Governance Principles on the Credit Risk of Private and Public Banks in Iran

Document Type : پژوهشی

Authors

• Sareh Dorafshanian ¹
• Mostafa Salimifar ²
• Ali Hussein Samadi ³

¹ PhD Student of Ferdowsi University of Mashhad

² Professor Department of Economics, Ferdowsi university of Mashhad, Mashhad, Iran

³ Professor Department of Economics, Shiraz University, Shiraz, Iran

https://doi.org/10.22067/mfe.2021.16455.0

Abstract

Abstract Expanded
 
1-INTRODUCTION
This study aimed to estimate and compare the effect of applying some principles of corporate governance on credit risk of selected private and public banks in Iran during 2011-2018. In the present study, after calculation of the credit risk by using the Basel Committee's proposed model for each bank, the relationship between shareholder rights and board size as two variables representing corporate governance principles, bank size and return on assets as control variables on the credit risk has been estimated. The results of the study indicate that in both groups of public and private banks, shareholder rights have no significant effect on credit risk. Increasing the size of the board of directors in public banks reduces credit risk more than private banks. Increasing the size of banks increases the credit risk in both groups of public and private banks. In private banks, increase in return on assets reduces credit risk, whereas in public banks, return on assets has no significant effect on credit risk.
 
 
 
2-THEORETICAL FRAME WORK
Banks are encountered with numerous risks, including liquidity risk, reputational risk, market risk, exchange rate risk, and credit risk, in their business process, which are posed by several factors in the banking system. Credit risk is one of the main financial market risks, which has long been a hotbed for debates and leads to the bankruptcy of financial institutions such as banks Nowadays, high credit risk is considered as one of the major causes of bank bankruptcy The term ‘bankruptcy’, however, can not be easily defined, and each financial institution can define a situation in which bankruptcy occurs. Generally, this concept can be defined as follows: A delay in repaying the debts or the interests of the loans. Moody (2005) defines bankruptcy as a failure or delay in repaying bank debts or their interest. In another definition, it is referred to as borrower’s failure or unwillingness to repay debts. According to the guidelines of the Basel Committee, as a subcommittee of the International Settlement Bank and the supreme international body involved in banking supervision, credit risk involves three main parameters:
1) Probability of Default (PD): The probability of failure in a customer to fulfill his commitments regarding repaying debts.
2)  Loss Given Default (LGD): Amount of loss (in assets) caused by bankruptcy and not compensated by the party of the contract.
3) Exposure at Default (EAD): This term indicates the maximum risk tolerated and accepted during bankruptcy.
3-METHODOLOGY
As maintained, corporate governance principle is one of the main variables, whose critical impact on the credit risk has been of concern over the last two decades. According to the OECD (2004), corporate governance encompasses a series of relations among managers, board members, shareholders, and other stakeholders. It provides a framework through which the organizational goals are identified. Appropriate corporate governance provides extensive and efficient monitoring in achieving the goals. Corporate governance contains the method of defining the strategic objectives of the company, the means of achieving such objectives, and the methods of monitoring the performance and relations in the company. The corporate governance aims at transparency and effective use of resources to modify the relationships among stakeholders. It also promotes the credibility and belief of shareholders and stakeholders, attracts more investment, and protects existing investments as well. Furthermore, it offers a system for controlling and balancing the enterprises. The guidelines of the Basel Committee highlight the need to apply corporate governance principles to improve the credit risk management process.
 The method proposed in this study to estimate the credit risk of the banks was based on the Basel Committee’s proposal on credit risk management. For this purpose, each bank's credit risk was estimated as an internal and unique variable for the same banks.
4-RESULTS
The most significant finding of this study deals with the return on assets in the private and public banks. According to the findings, while increasing the return on assets in the private banks reduces credit risk, an increase in the return on assets in the public banks has no significant impact on their credit risk. This might be due to the lack of transparency in the data and financial statements and its components by the public banks as these banks publish statistics based on the expectations of their performance rather than the reality of the performance. In other words, they submit manipulated financial statements with some unreal rows, which makes our rational assumptions underpinned by some theoretical foundations on the inverse relationship between return on assets and credit risk not be observed in Iran’s public banks. To put it in other words, the return on assets presented by the public banks is often the result of unreal revaluations of assets, regardless of depreciation, but not the actual increases in the return on assets.
5-CONCLUSIONS & SUGGESTIONS
Throughout the last two decades, credit risk has been the most important challenge with which the banks have been tackling as such they have always sought to identify and manage effective variables to minimize losses. The studies over the past two decades have highlighted the impact of corporate governance on the stability and risk decrease in financial institutions. This study aimed to estimate the credit risk in private and public banks listed in stock exchange and to analyze and compare the impact of board size and shareholder rights (as a corporate governance proxies) along with the size of the banks, and their return on the credit risk of these two groups. According to the findings and as a practical recommendation, there should be legal requirements for the banks to homogenize the dissemination of their data and information. Furthermore, providing the grounds to clarify the performance of the banks in terms of their assets and liabilities and to disseminate realistic information in the relevant communities would lead the findings of the studies on the banking system toward reliable theories and make them closer to the real world.

Keywords

• Credit risk
• corporate governance
• Private banks
• public banks
• Shareholder rights
• Board size

References

 

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