Abstract

Poor corporate governance practices have been cited as contributory to the 2007 global financial crisis. The chapter explores a qualitative self-regulation approach to address a major risk facing banks using the Basel Committee on Banking Supervision (BCBS) framework of internal controls. The study examines the effect of the qualitative principles of the BCBS internal control framework on credit risk. Corporate institutions use internal control frameworks to address the most operational risks, but the current study hypothesizes a possible relation with the credit risk. This research covers banks from selected EU countries covering some period before and after the 2007 financial crisis using a fixed-effect model. We report a significant relationship between board functions and activities, board structure and board monitoring, and credit risk. The results indicate that investment in high-risk assets, bank profitability and board chair being ex-CEO increases credit risk in European banking. The chapter extends the scope of a previous work that used the elements of the COSO internal control framework on a single country. This quantitative measure of qualitative constructs of the framework complements existing research that uses algorithms and simulations to study credit risk.

Highlights

  • The aftermath of the 2007 global financial crisis led to the tightening of corporate governance practices among financial institutions

  • This study explores qualitative self-regulation approach using the Basel Committee on Banking Supervision (BCBS) internal control framework to investigate how internal controls affect credit risk in European banking

  • We propose the use of the BCBS internal control framework to minimize bank credit risk

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Summary

Introduction

The aftermath of the 2007 global financial crisis led to the tightening of corporate governance practices among financial institutions. To the best of our knowledge, this is the first chapter to use the BCBS internal control framework to study its relationship with credit risk within the European banking. Anytime banks intensify efforts to strengthen internal control weaknesses, there were reductions in provisions and loan loss reserves [7] Based on their findings, we propose the use of the BCBS internal control framework to minimize bank credit risk. This implies there is still room for banks to improve upon their corporate governance practices to deepen and sustain investor confidence in the banking system For this reason, we suggest an internal control framework that is quite exhaustive in addressing the menace of investor losses such as credit risk. The rest of the sections cover hypotheses development, methodology, results and discussion, and conclusion

Basel Committee of Banking Supervision framework for internal control systems
Thirteen principles of the BCBS internal control framework
Credit risk
Hypotheses development
Board functions and activities
Board structure
Board monitoring and control
Control variables
Data and methodology
Internal controls variables
Results and discussion
Conclusion
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