Nationality Diversity of Bank Boards Miroslav Nedelchev Economic Research Institute, Bulgarian Academy of Sciences, Bulgaria mknedelchev@abv.bg Abstract The aim of this paper is to carry out a comparative study for nationality diversity in bank boards. The study covers practices of board diversity of nine commercial banks. The data are compared for subsidiary banks in Bulgaria and their parent banks from the home country. The study defines a high degree of nationality diversity in subsidiary banks. The Bulgarian banks have a higher number of foreign members on boards compared to their parent banks. The good practices on board diversity in Bulgarian banks are a consequence of their subordination in European financial conglomerates and are aimed to reduce agent conflicts. Keywords: corporate governance, subsidiary banks, Bulgaria, comparative study ORIGINAL SCIENTIFIC PAPER RECEIVED: NOVEMBER 2017 REVISED: FEBRUARY 2018 ACCEPTED: FEBRUARY 2018 DOI: 10.2478/ngoe-2018-0001 UDK: 336.71.025.13(497.2) JEL: G21, G34, M14 Citation: Nedelchev, M. (2018). Nationality Diversity of Bank Boards. Nase gospodarstvo/Our Economy, 64(1), 3-10. DOI: 10.2478/ngoe-2018-0001 Introduction The effects of financial crisis reveal weaknesses in corporate governance of banks and highlight the need to balance independence and competences of boards (European Commission, 2010). The application of good corporate governance practices, including diversity of board composition and structure, will increase the competitiveness and sustainability of banks in the long run (European Commission, 2012). The diversity policy concerns recruitment of new board members and has impact on fit and proper test for managers (European Banking Authority, 2017). The diversity reflects the competences and views of board members. The low level of board diversity leads to a process called „group thinking", reducing debates, ideas and disputes in the decision-making process and ineffective supervision of managers (Cancer & Mulej, 2013). The diversity of a board contributes to weakening the phenomenon of „herd behavior" (European Banking Authority, 2016). Increasing diversity enables facilitation of understanding of the institution's activities and to ensure decision-making in an objective and constructive manner. Diversity can help to make better and more effective decisions about strategies and risk-taking, as members have the opportunity to benefit from a wider range of views, experiences, perceptions and values. The main objective of this study is to compare the board diversity by nationality in subsidiary banks in Bulgaria and their parent banks in the home country. Using quantitative data processing methods, the study achieves qualitative conclusions about the practices of nine banks. The data sources are Bulgarian National Bank and European Banking Authority. NG NASE GOSPODARSTVO OUR ECONOMY Vol. . 64 No. 1 2018 pp . 3-10 3 NAŠE GOSPODARSTVO / OUR ECONOMY Vol. 64 No. 1 / March 2018 The innovative nature of the diversity issue determines the limitations for our study: there is only one legislative source of information, the EU directives to reduce effects of the international financial crisis; otherwise, there is a small volume of published empirical data and scarce specialized literature. In accordance with the measures for prevention of future crisis in the EU, we formulated the following research hypotheses: H1: Nationality diversity of boards aims to increase the competitiveness and sustainability of banks; H2: Parent banks have a higher level of nationality diversity of boards than their subsidiary banks considering that they are: registered in the euro area, covered under EU directives and listed on stock exchanges. The structure of this study consists of three parts. In the first part is presented the emergence and development of concept for board diversity in the EU; in the second one, we consider the expected effects of this process; and the third part contains an empirical study, on the basis of which some basic findings are made. Finally, the findings of the study are specified and recommendations are given for future research. Emergence and Development of Diversity in Bank Boards Globalization strengthens and accelerates the process of capital exports, which is why the need for supervising abroad managers for fiduciary duties is growing. Another process, the European integration, has placed a third function of diversified boards on the agenda—knowledge of local legislation and customer preferences. For some countries from Eastern Europe, the adoption of market principles in the 1990s and the entry of foreign ownership into the banking system have further influenced the development of board diversity. In the EU was adopted a board diversity policy as a measure to reduce the effects of recent financial crises; among them, the leading causes are managers' behavior and, in particular, the lack of board control over managers' appetite for risk (Basel Committee on Banking Supervision, 2010). Although the data on foreign presentation in boards in the EU Member States are positive—1/3 of their members are foreign citizens (European Commission, 2011) and despite the adopted directives and harmonization process, the different levels of nationality board diversity in some cases are significant, from 54% for the Netherlands to 2% for Spain (IIC Partners, 2015). The diversity of bank boards arises in 2002 under the Sar-banes-Oxley Act in the USA through requirements to increase the presentation of women, minorities, young managers and persons without bank practice (Bjorklund, 2010). In 2009, radical steps have been taken in the EU to reformat good corporate governance practices and focus on protecting stakeholders rather than shareholders. Because of the introduction of measures to protect taxpayers and stakeholders since 2013, the EU banks are required to adopt an own corporate policy on board diversity to prevent future crises. The basic principles of diversity enforcement control are the classic „comply-or-explain" principle, the opinion by external auditors for reached results, and the good practice data by competent authorities. The issue of the importance of board diversity on reforms for good corporate governance practices is found in several documents: - The European Commission published its „Green paper: Corporate governance in financial institutions and remuneration policies" (European Commission, 2010), which includes measures to tackle the effects of financial crises. The main reason for crisis is the lack of effective control by boards over managers and, accordingly, insufficient resources to assess risks. A direct reflection of this disadvantage is found in the lack of diversity in social and personal characteristics of the board (gender, social and cultural background, education, nationality). - In „Action Plan: European company law and corporate governance - a modern legal framework for more engaged shareholders and sustainable companies" (European Commission, 2012), the European Commission sets requirements for greater transparency regarding diversity policy and clarifies the Green paper's (2010) terminology. The initiative is complementary to the proposal to improve diversity for non-executive board members of listed companies only. - The Directive 2013/36/EU makes recommendations for encouraging independent opinion and facilitating constructive criticism in boards. In the appointment of board members, the Member States and competent authorities should require banks and nomination committees to take into account a wide range of criteria for skills and abilities held by applicants. To this end, the banks need to develop policies to promote diversity in the boards in terms of age, gender, nationality, education and professional experience. The Directive includes the following requirements: the financial intermediaries to establish a nomination committee that identifies and recommends for approval of the board or the general meeting of shareholders the filling of seats in management bodies, taking into account the balance of knowledge, skills, diversity and experience of board members; the financial institutions to develop a policy to promote 4 Miroslav Nedelchev: Nationality Diversity of Bank Boards diversity in boards; and the competent authorities of the Member States to provide information on the diversity to the European Banking Authority to compare diversity practices at the EU level. - The European Banking Authority provides a summary of diversity of boards in the European Union since 2016 (European Banking Authority, 2016). The data of national competent authorities are processed and compared to improve the good practices of individual banks. Diversity of nationality is of particular importance to overseas banks, as they combine business activity and expertise in the relevant market. The nationality diversity allows a board to take better account of cultural values, as well as legal and market circumstances. Effects of Board Diversity During the latest financial crisis, it became clear that corporate governance had not functioned as expected (Pasic, Bratina and Festic, 2016). The recommendations contained in the EU directives (Directive 2013/36/EU, Directive 2014/59/EU, Directive 2014/65/EU) on the diversity of bank boards are related to the achievement of the following expected effects: - effective risk control and sustainability of financial institutions; - independently viewing and facilitating of constructive criticism; - balance of knowledge, skills and experience of board members; - balance between independence and competences of board members; - objectivity and independence in assessing the qualities of members in order to exercise control over efficiency of management; - sound and prudent management, promoting market integrity and protecting investors' interests; - understanding of the bank's activities, including the main risks; - avoiding „group thinking"; - adequate representation of the population; - understanding of cultural values, market peculiarities and legal frameworks. There is a recommendation to add several forms of diversity for achieving greater effects (Garcia-Mecaa et al., 2015). The tendency is a composition of boards to achieve diversity in terms of: - age; - gender; - nationality; - education and professional experience. An additional form of diversity is a representation of employees and workers in management. This is an appropriate way to promote diversity by adding a key point of view and real knowledge of the institution's internal functioning. Nationality Diversity of Bank Boards: The Bulgarian Practice The European Commission's recommendations on diversity are primarily related to non-executive members of bank boards (European Commission, 2011). Diversity policies refer to the members of a supervisory board in a two-tier system and to the non-executive members of a board of directors in a one-tier system (Nedelchev, 2017b). The majority of Bulgarian banks are with foreign ownership, which explains the prevalence of two-tier management systems in Bulgaria (Nedelchev, 2017a). The Bulgarian National Bank identifies nine Bulgarian banks as subsidiaries of European financial groups: Allianz Bank Bulgaria, DSK Bank, EIBank, Eurobank Bulgaria, Procredit Bank Bulgaria, Raiffeisen Bank, Societe Generale Expressbank, Unicredit Bulbank, and United Bulgarian Bank (Bulgarian National Bank, 2017). These banks have an average of 5.4 persons as the number of board members. The largest number of board members (seven natural persons, i.e., the maximum number of members foreseen in a supervisory board under the national legislation) has banks from Germany and Italy (Figure 1). The bank boards in Bulgaria are over-internationalized. The average percentage of Bulgarian members on boards is relatively low (12%), which can be explained by the high foreign share in bank ownership. In more than half of Bulgarian banks, the chairman of the board is a foreign citizen. Procredit Bank Bulgaria has the most Bulgarian members on the board (40%), and in four banks (DSK Bank, EIBank, Raiffeisen Bank and United Bulgarian Bank), the boards are entirely foreign (Figure 2). The majority of Bulgarian banks (73%) are overseas subsidiaries of banking groups from the EU; these groups are listed on stock exchanges and are within the scope of EU directives, as they are registered in the Euro area (Houbenova-Delisivkova, 2015). The nationality diversity in subsidiary banks is a fact: 88% of board members are foreign citizens, while in parent banks, 27% are foreign (Figure 3). Depending on the origin of capital, the banking boards in Europe fall within two types and differ in their function 5 NAŠE GOSPODARSTVO / OUR ECONOMY Vol. 64 No. 1 / March 2018 Figure 1. Foreign subsidiary banks in Bulgaria 2 s k n a b f ° 1 r e b 12 1o Austrian banks Belgian banks French banks number of banks German banks Greek banks Hungarian banks Italian banks number of board members Source: Bulgarian National Bank, 2017 Figure 2. Nationality diversity of bank boards in Bulgaria 10- e b e b Austrian banks Belgian banks French banks German banks Greek banks Hungarian banks Italian banks number of Bulgarian members number of foreign members Source: Bulgarian National Bank, 2017 (International Finance Corporation, 2012). In banks with local capital, the boards are created to comply with regulatory requirements rather than to add value to bank operations. For banks with foreign capital, the boards are formality; they focus on implementing the decisions of the head offices and establishing close relationships with management without sufficient knowledge of the local environment. In subsidiary banks, the foreign board members reflect the origin of capital, and in parent banks, their own professionalism (Figure 4). 6 s 6 4 2 o o s 6 4 2 o Miroslav Nedelchev: Nationality Diversity of Bank Boards Figure 3. Nationality diversity of boards in Bulgarian subsidiary banks and their parent banks Figure 5. Number of foreign members in Bulgarian bank boards 50 40 30 £ 20 UK; 1 10- 0- subsidiary banks parent banks number of local members number of foreign members Source: Bulgarian National Bank, 2017 Italy; 4 Hungary; 7 Greece; 5 Austria; 8 Belgium; 7 Croatia; 1 France; 3 Germany; 7 Source: Bulgarian National Bank, 2017 Figure 4. Nationality of foreign board members in Bulgarian subsidiary banks and their parent banks 1. ill Il II..I. e -Q n CTI ei r o an ie ns an ie (U +J CÛ 'u ns an •-