[Editorial] Outside Director System

The Korea Federation of Banks announces today guidelines on the outside director system, which recommends bank holding companies to name different people for CEO and chairman of the board, and to hold a de facto selection of a new board chairman every year. The terms of outside directors will also be limited to five years and banks will be urged to set differences in terms for outside directors by replacing 20 percent of them every year.

The outside director system for banks was first adopted in 1997 to bring in external expertise to management and keep bank presidents and executives in check. The system’s role has become increasingly significant to the point that it has become the very core of bank governance. In the process, however, collusion with bank presidents and incidents of moral hazard have arisen. For example, a company headed by an outside director of KB Financial Group won an IT contract with Kookmin Bank. Another dispute broke out when outside directors received overlapping pay for attending meetings of several subcommittees on the same day. Outside directors even decided the details of their recruitment and benefits themselves.

The Financial Supervisory Service identified such problems in a probe conducted early last year, but measures for improvement came belatedly after several scandals broke out. Since the improvement involved no law revisions, the financial watchdog could introduce the measures much earlier. It brought up the personal flaws of outside directors to prevent an individual (Kookmin Bank President Kang Chung-won) from being elected KB Financial Group chairman while the election was in progress. Such a practice against the usual order raised controversy over state control of the financial industry. Therefore, financial authorities should focus on bank governance and improvement measures instead of the appointment of a specific person.

The guidelines are a compilation of “best practices” and hold no binding legal authority. Private banks can decide on their governance considering the interests of their shareholders and depositors and their soundness. For example, if a bank CEO becomes a board chairman simultaneously, it is difficult to keep him or her in check. Management efficiency could also suffer if the roles of CEO and board chairman are separated. Therefore, it is up to each bank to decide which structure is more appropriate. Nevertheless, transparency of substance and procedures is needed no matter what. If a bank does not follow the guidelines, it must announce the rationale behind its decision to investors.

Another point of contention about outside directors is their lack of expertise or autonomy critical to their jobs due to management influence. Less than 10 percent of outside directors of banks and bank holding companies are financial experts. As stressed by the Organization for Economic Cooperation and Development, a bank should determine whether the role of outside directors has become perfunctory within its organization. In addition, securities and insurance companies should also check if their outside director systems are running efficiently and make improvements if needed.