International scandals and recent financial and economic crises, especially the European sovereign debt crisis, have led to renewed interest in corporate governance, in particular banking governance. As such, in recent years banking governance has become one of the most debated subjects [BEN 10, BEN 13a]. As a fundamental economic concept, corporate governance has come to the attention of media and of academics [BEN 15, LEV 15]. Corporate governance is a set of mechanisms that affect how a corporation is operated. It deals with goals and welfare of all the stakeholders, including shareholders, management, board of directors and the economy as a whole. Adams et al. [ADA 10] argue that the firm is confronted by a myriad of governance-related problems and that its governance structure emerges as its best response to those problems. Hence, given the heterogeneity of governance issues faced by firms, it is unlikely that a unique governance policy is in the best interest.

In contrast to the failures in the conventional banking sector, Islamic banks did not announce substantial write-offs during the financial crisis but have been rather resilient [CHA 09, CHA 10, GRE 10]. While conventional banks have faced significant difficulties, Islamic banks seem to have fared better during the global financial crisis [MOL 15]. We must note that Islamic finance represents only 1% of global finance [LEV 16].

In this book, we review the theoretical and empirical research of banking corporate governance and its main mechanisms, especially in comparative banking governance between conventional banks and Islamic banks, and thus present the different tools used in banking performance and risk-taking. We highlight banks because they are the engine of the economy and their bankruptcy disrupts the whole economic system. These strong externalities on the economy make the corporate governance of banks a fundamental issue. Well-governed banks will be more efficient in their functions than those governed poorly [LEV 04].

Seeing the phenomenal growth of Islamic finance and the supply of Islamic financial products and services around the world by many banks, including well-known institutions, may be crucial to understand the features of Islamic banking and Islamic banking governance. Not only the good governance of banks is important; the question arises as to whether they are different from other corporations. Banks appear with new questions to the corporate governance problem due to their specific characteristics and their regulated condition.

Recently, Mollah and Zaman [MOL 15] examined whether Shariah supervision helps Islamic banks perform better and create shareholder value during the period 2005–2011. In particular, they focused on exploring the effect of (1) Shariah boards, (2) board structure and (3) CEO power on the performance of Islamic banks vis-à-vis conventional banks. Their analysis of bank performance and governance shows that boards of Islamic banks are more independent compared with their conventional counterparts and that conventional banks recruit more internal CEOs than Islamic banks. The small boards in Islamic banks and Shariah boards seem to be profit driven, but independent directors are associated with a decline in the performance of Islamic banks. They find different results between Islamic and conventional banks. Therefore, they conclude that the “multilayer” corporate governance model instituted in Islamic banks helps them to perform better than conventional banks, but this is due to inbuilt Shariah mechanisms in Islamic banking. Despite concerns about their independence and limited monitoring ability, they find that Shariah boards play a significant role in protecting shareholder interest and affect the performance of Islamic banks. They also find that board structure and CEO power are also an important influence on the performance of Islamic banks.

Our reflection can be briefly summarized around the following questions:

1. 1) why has corporate governance become more important?
2. 2) what is special about the banking governance of Islamic banks?
3. 3) what are the different measures of banking performance?
4. 4) what is the impact of banking governance on performance?
5. 5) how can we analyze and manage banking risks?
6. 6) what is the impact of banking governance on risk-taking?

Corporate governance relates to the manner in which the business of the bank is governed, including setting corporate objectives and the bank’s risk profile, aligning corporate activities and behaviors with the expectation that the management will operate in a safe and sound manner, running day-to-day operations within an established risk profile, while protecting the interests of depositors and other stakeholders. It is defined by a set of relationships between the bank’s management, its board, its shareholders and other stakeholders¹. La Porta et al. [LA 00] pointed out that corporate governance has an important influence on the development of financial markets and corporate values, and that, as a whole, financial markets are developed in order to protect the rights of investors. They find that firms in countries that provided better protection to shareholders, on average, had a higher Tobin’s Q. However, Johnson et al. [JON 00] indicate that corporate governance mechanisms could explain the depreciation of the currency and the extent of the decline in the stock market more than macroeconomic factors during the Asian financial crisis. They also found that those countries that provided better protection to minority shareholders suffered less severely than those that only provided weak protection to minority shareholders during the Asian financial crisis. Claessens et al. [CLA 02], using a sample of nine countries in Asia, showed that corporate value would be greater in firms with higher cash flow rights held by controlling shareholders.

Mitton [MIT 02], by using the five countries, the most affected by the Asian financial crisis as his sample (Indonesia, South Korea, Malaysia, the Philippines and Thailand), noted that firms with better corporate governance had smaller declines in their stock prices during the financial crisis. The major findings of Mitton [MIT 02] also state that the stock price would perform better when the firm had a higher quality of information disclosure or a greater concentration of external shareholdings, where a higher quality of information disclosure meant that the firm had an American depositary receipts offering, or that its financial statements had been audited by a Big-Six accounting firm. Mitton [MIT 02] also find that the decline in the stock price was smaller for firms whose activities were concentrated than for diversified firms. In addition, Lemmon and Lins [LEM 03] indicate that the stock price decline during a financial crisis was greater when a firm’s controlling shareholders had greater control rights and smaller cash flow rights. Joh [JOH 00] indicates that corporate profitability would be lower if the firm had lower ownership concentration, or if there was a high disparity between control rights and ownership rights, which suggests that corporate governance impacts accounting performance.

Using data for a sample of South Korean firms during the Asian financial crisis, Baek et al. [BAE 04] find that corporate governance had an influence on the decline of stock prices. They indicated that the decline in a firm’s stock price during a financial crisis was smaller when that firm’s unaffiliated foreign investors accounted for a larger shareholding within the firm or a better quality of information disclosure, and that the decline in the stock price during this period was larger when the controlling family in the firm had a larger shareholding or when the voting rights of the controlling shareholders were greater than their cash flow rights. Moreover, Klapper and Love [KLA 04] pointed out that better corporate governance helps improve operating performance and raises the firm’s market value, and so corporate governance is more valuable when the minority shareholders are not protected enough by the legal environment.

Beltratti and Stulz [BEL 12] and Fahlenbrach and Stulz [FAH 11] analyze the influence of corporate governance on bank performance during the credit crisis: by analyzing the influence of CEO incentives and share ownership on bank performance Fahlenbrach and Stulz [FAH 11] find no evidence for a better performance of banks in which the incentives provided by the CEO’s pay package are stronger. In fact, their evidence points to banks providing stronger incentives to CEOs performing worse in the crisis. A possible explanation for this finding is that CEOs may have focused on the interests of shareholders in the build-up to the crisis and took actions that they believed the market would welcome. However, these actions were costly to their banks and their shareholders when the results turned out to be poor. Moreover, their results indicate that bank CEOs did not reduce their stock holdings in anticipation of the crisis and CEOs did not hedge their holdings. Hence, their results suggest that bank CEOs did not anticipate the crisis and thus the resulting poor performance of the banks as they suffered huge losses themselves. Beltratti and Stulz [BEL 12] investigated the relationship between corporate governance and bank performance during the credit crisis in an international sample of 98 banks. Most importantly, they find that banks with more shareholder-friendly boards as measured by the “corporate governance quotient” obtained from Risk Metrics performed worse during the crisis, which indicates that the generally shared understanding of “good governance” does not necessarily have to be in the best interest of shareholders. They argue that “banks that were pushed by their boards to maximize shareholder wealth before the crisis took risks that were understood to create shareholder wealth, but were costly ex-post because of outcomes that were not expected when the risks were taken”.

Moreover, Erkens et al. [ERK 10] investigated the relationship between corporate governance and performance of financial firms during the credit crisis of 2007/2008 using an international sample of 296 financial firms from 30 countries. Consistent with Beltratti and Stulz [BEL 12], they find that firms with more independent boards and higher institutional ownership experienced worse stock returns during the crisis. They argue that firms with higher institutional ownership took more risks prior to the crisis, which resulted in larger shareholder losses during the crisis period. Moreover, firms with more independent boards raised more equity capital during the crisis, which led to a wealth transfer from existing shareholders to debt holders. Minton et al. [MIN 10] investigated how risk-taking and U.S. banks’ performance in the crisis relate to board independence and financial expertise of the board. Their results show that the financial expertise of the board is positively related to risk taking and bank performance before the crisis but is negatively related to bank performance in the crisis. Finally, Cornett et al. [COR 11] investigate the relation between various corporate governance mechanisms and bank performance in the crisis in a sample of approximately 300 publicly traded U.S. banks. In contrast to Erkens et al. [ERK 10], Beltratti and Stulz [BEL 12] and Fahlenbrach and Stulz [FAH 11], they find better corporate governance, for example a more independent board, a higher pay-for-performance sensitivity and an increase in insider ownership to be positively related to the banks’ crisis performance.

This book is organized as follows:

• – Part 1: From Corporate Governance to Banking Governance: in this part, we review the academic literature trying to understand the special features of the corporate governance, the banking governance and the Islamic banking governance, and the different mechanisms of corporate governance;
• – Part 2: Banking Performance: this part is divided into three chapters, the first chapter deals with the different performance measurement tools, which vary among traditional and modern methods, the second chapter is about the relationship between corporate governance and performance and the third chapter presents banking governance and performance;
• – Part 3: Banking Risk-Taking: this part is divided into three chapters; in the first two chapters, the banking risk analysis and management are discussed, and in the last chapter, we expose the relationship between corporate governance and risk taking by banks.