Guide to Rules and Best Practices for Corporate Governance of Specialized Lending Institutions in Palestine

2017

Table of Contents

Message from the Governor ................................................................................... 3 Introduction ........................................................................................... 4 Objectives and Importance of Governance ............... ......................................................... 4 Key Definitions in the Guide ................................................................ 5 Structure and Contents of the Guide .......................................................................... 7 Scope of Application ................................................................................... 7 Governance Principles .................................................................................. 7 Principle One: Board of Directors Duties................................................................ 7 Principle Two: Qualifications and Composition of Board Members............................................. 11 Principle Three: Board Committees................................................................ 13 Principle Four: Senior Executive Management............................................................... 21 Principle Five: General Assembly Meetings ........................................... 23 Principle Six: Internal Control, Supervision, and Audit................................................. 26 Principle Seven: Social Responsibility............................................................. 35 Principle Eight: Governance Requirements for Institutions Practicing Islamic Financing........................ 37

1. Introduction

Corporate governance occupies a significant space in the specialized lending industry amid its pursuit of achieving greater expansion and profitability, and sustainability. Institutions must strive to minimize the likelihood of losses or operational failure. The core of governance is for the Board and Executive Management to assess the risks facing the institution and ensure the provision of necessary internal control systems to reduce vulnerability points. Responsibility lies with both in risk management processes and in defining the methodology required for strong internal control systems. If these institutions cannot manage their risks effectively, they will fail to achieve their social and financial objectives. This leads to a loss of confidence among donors, lenders, and clients, ultimately depriving the institution of its funding sources. It becomes impossible to achieve its social objectives in serving target groups, threatening its operational sustainability. Poor corporate governance poses a major risk to these institutions, becoming a significant obstacle to sustainable growth due to a sharp decline in portfolio quality that is difficult to control. The objective of this guide is to provide a methodology for these institutions to address these challenges proactively. This guide was prepared as a primary reference to assist these institutions in developing their own rules to comply with corporate governance best practices, which will contribute to achieving their mission and protecting their assets.

2. Objectives and Importance of Governance for Specialized Lending Institutions:

a. Contribute to maintaining the stability of specialized lending institutions. b. Enhance the risk management process and mitigate credit and operational risks, while managing the institution prudently in accordance with international standards. c. Activate the role of the supervisory board. d. Develop investments and encourage capital inflows to finance institutions at the lowest possible costs. e. Enhance trust with stakeholders. f. Strengthen the internal control and supervision environment within institutions. g. Increase institutions' capacity to confront crises and mitigate their impacts.

3. Key Definitions in the Guide:

3.1 Governance: From the perspective of the Monetary Authority, it is defined as "the set of relationships, rules, procedures, and principles that ensure the institution is managed prudently to achieve the interests of stakeholders in a manner consistent with laws, instructions, and best practices in the field of specialized lending, thereby ensuring the preservation and development of the institution." 3.2 Institution(s): A licensed specialized lending institution/company by the Monetary Authority. 3.3 Board: The Board of Directors of the institution. 3.4 Chairman: The Chairman of the Board of Directors of the institution. 3.5 Member: A Board of Directors member of the institution. 3.6 Senior Executives: The General Manager, their deputies and assistants, department and branch managers, and individuals holding similar responsibilities regardless of job title, including: • Regional Managers. • The Sharia Supervisor in institutions providing Islamic financing. • The Anti-Money Laundering Compliance Officer. • Any individual carrying out similar responsibilities to the above categories regardless of job title. 3.7 Significant Shareholding: A shareholding equal to 5% of the institution's capital or voting power. 3.8 Controlling Shareholder or Controlling Group: A relationship where a person or group of natural or legal persons achieves any of the following: a. A person or group of natural or legal persons, or their combination, working together or related up to the second degree, directly or indirectly owns 20% or more of the institution's shares or voting power. b. The ability to appoint the majority of the institution's directors. c. Direct or indirect ability to exercise effective influence on the institution, and/or on its Board of Directors members, and/or on its senior executives or decisions issued by them. 3.9 Independent Member: A Board of Directors member who meets the following conditions: a. Their shareholding, or that of any of their relatives up to the second degree, does not exceed 0.5% (five per thousand) of the institution's shares. b. They are not a member of a group of natural or legal persons exercising control over the institution. c. They do not work or have not worked in an executive position at the institution or any of its affiliated institutions, or institutions holding shares in it, during the previous three years. d. They do not receive any salary or financial amount from the institution except what they receive for their board membership and/or dividends received as a shareholder. e. They do not work in an institution providing advisory, professional, or other services, or supplying goods, to the institution or any of its affiliates, nor do they personally provide such services or supply such goods. f. They are not related by kinship up to the second degree to any other board members or senior executive management of the institution. g. They do not have a direct or indirect interest with any person (natural or legal) who has obtained facilities from the institution exceeding ten thousand dollars in value. h. They do not hold an executive position in any entity where any of the institution's executive directors serves on its board of directors. i. They are not an employee or partner of the institution's external auditor during the previous years preceding their board nomination, nor do they have a direct or indirect interest with this auditor or any of its affiliated institutions. j. In addition to the above independence conditions, the independent member must possess expertise and specialization in financial, banking, or specialized lending matters, and hold a university degree in financial and banking sciences, business administration, accounting, or any related field. 3.10 Conflict of Interest: A situation where a natural or legal person is in a position where there is a suspicion of obtaining a direct or indirect special interest, benefit, or advantage for themselves or others, or which affects their ability to perform their duties and responsibilities objectively and with integrity. 3.11 Risk Appetite Framework: The overall approach, including policies, procedures, controls, and systems, through which the institution's willingness to take risk, risk limits, and the broad outlines of roles and responsibilities overseeing the execution and monitoring of the risk appetite statement are defined. The risk appetite statement must consider the institution's material risks and reputational risks, and align with the institution's strategic objectives. 3.12 Risk Appetite Statement: A written formulation of the overall level of risk types the institution will accept or avoid to achieve its objectives. This statement includes quantitative methods for profits and capital, risk and liquidity metrics, etc., as well as qualitative methods for addressing reputational risk, behavioral risk, and risks related to money laundering and unethical practices.

4. Structure and Contents of the Guide:

This guide contains a set of mandatory rules. Each institution must annually prepare a report including a self-assessment of compliance with the guide's requirements and submit this assessment to the Monetary Authority no later than the first quarter of the following year. Each institution must also disclose in its annual report to shareholders the extent of compliance with governance standards or the reasons for non-compliance wherever applicable.

5. Scope of Application:

The requirements of this guide apply to all specialized lending institutions regardless of their legal forms and differing objectives. The Monetary Authority exempts certain institutions from some conditions, provisions, and requirements of this guide based on the size and nature of their operations.

6. Governance Principles:

6.1 Principle One: Board Duties

The Board is primarily responsible for the institution, including supervising executive management's work. This supervision involves monitoring executive management's implementation of the policies, objectives, and strategic plans established by the Board, including the governance policy, internal control systems, risk management, institutional values, and the institution's social mission.

Board Responsibilities:

1. Elect a Chairman and Vice-Chairman as needed by the institution and according to its internal regulations.
2. Represent the institution before regulatory and other official authorities, and before all stakeholders.
3. Define objectives, formulate strategies and general policies for the institution, including risk strategy and financial safety, and monitor and direct executive management in their implementation.
4. Approve the organizational structure and job descriptions for positions in the institution to achieve its objectives.
5. Bear responsibility for managing the institution by directly supervising senior executive management. Each board member must recognize that, by law, they bear personal responsibility before regulatory authorities, the institution, and shareholders in case of violating their legal duty, and may face legal action from the institution or shareholders in such cases.
6. Approve internal control and supervision systems and ensure executive management's compliance with them, working to re-evaluate and improve these procedures.
7. Approve a comprehensive risk management system, including risk appetite and risk statements, and monitor executive management's compliance with them.
8. Approve anti-money laundering and counter-terrorist financing policies.
9. Approve administrative and financial systems, salary scales, financial and administrative authority matrices, and any other important systems for the institution's operation, and review and amend them to achieve institutional objectives.
10. Form board committees to assist in performing duties without relieving the Board of direct responsibility for their work, and define their responsibilities, authorities, and operating systems.
11. Monitor and supervise the institution's various activities and ensure compliance with applicable laws, regulations, instructions, decisions, and internal systems.
12. Approve a general disclosure and transparency policy, ensuring disclosure through all available means and in all necessary reports at the appropriate time, accurately and in detail about the institution, including quantitative and qualitative information. This policy must be written and approved, and include all important and necessary disclosures for stakeholders, whether shareholders, borrowers, donors, regulatory and government authorities, or any other relevant parties.
13. Approve a general policy and clear procedures to identify conflict of interest situations, including necessary measures to prevent or avoid actual or potential conflicts of interest in the institution. This ensures that all board members, senior executives, and employees make every possible effort to avoid conflicts of interest, and disclose in writing any situation that may involve a conflict of interest.
14. Appoint senior executives and determine their salaries and bonuses, in accordance with the employment and appointment policy approved by the Board.
15. Determine the institution's need to contract with experts and consultants based on executive management's recommendations, and determine their fees and contract terms.
16. The Board must consider the legitimate interests of all stakeholders, and must ensure the institution maintains a constructive relationship with the Monetary Authority.
17. Ensure the review of transactions with related parties, assess their risks, verify the safety of these transactions, ensure no conflict of interest, and prevent related parties from misusing them.
18. Ensure fair treatment of all shareholders, including minority shareholders and other stakeholders.
19. Exert sufficient effort and due care to preserve and develop the institution's assets and achieve its objectives.
20. The Board must perform its entrusted duties with utmost loyalty, prioritizing the institution's interests over any personal considerations when making decisions. They bear individual and collective responsibility for any negligence or omission that harms the institution.
21. The Board must adopt a code of professional conduct for board members and employees at all levels and job titles, including professional standards and institutional values that enhance integrity, loyalty, trustworthiness, and commitment. These values must reflect on the Board's and employees' performance and behavior. The Board must also ensure the distribution of the code of conduct to its members and employees, and provide them with necessary training to ensure optimal implementation of its provisions.
22. Convene General Assembly meetings, both ordinary and extraordinary, and prepare agendas.
23. Approve interim (semi-annual) audited and final audited financial statements prepared by the external auditor, ensure all necessary and important disclosures are available to inform all relevant parties, and recommend their approval to the General Assembly.
24. Recommend to the General Assembly the election of the institution's external auditor after obtaining the Monetary Authority's approval.
25. Recommend to the General Assembly, after obtaining the Monetary Authority's approval, the election of Sharia Supervisory Board members (in institutions providing Islamic financing), determine their appointment conditions, and ensure their neutrality and operational independence.
26. The Board must evaluate the performance of its committees annually and make necessary amendments to their membership, duties, and authorities.
27. Allocate sufficient resources for senior executive management to perform its responsibilities independently and effectively.
28. Establish performance evaluation criteria for senior executive management that align with the institution's long-term objectives, strategy, operational plans, and acceptable risk level.
29. Hold regular meetings with senior executive management, discuss reports submitted by them, and inform senior executive management of the institution's future plans and directions.
30. Any other duties specified by the Banks Law or the regulatory system governing specialized lending institutions' operations, instructions and decisions issued thereunder, and any other legislation and instructions issued in this regard, in addition to the institution's internal regulations.

Board Meetings:

1. The Board holds ordinary meetings no less than six times during the year, at intervals of every two months. Ordinary meetings are scheduled during the year at the Board's first meeting at the beginning of the year. Extraordinary and emergency meetings are held as needed to discuss urgent and pressing matters.
2. The Board must appoint a Board Secretary who is independent of executive management, whether a board member, legal advisor, or a designated employee for this purpose, as the Board deems appropriate.
3. The Board Chairman must distribute the agenda and meeting documents to all board members sufficiently in advance, no less than one week, and document the receipt and acknowledgment of invitations and attachments by all board members.
4. All board members must maintain confidentiality of deliberations. Members whose presence may constitute a conflict of interest regarding specific topics must leave the meeting, and this must be documented.
5. Sufficient time must be allocated for agenda items, with due attention paid to minimizing the inclusion of "Any Other Business" on meeting agendas.
6. The Board Chairman or Secretary must ensure all board members receive the agenda, necessary documents, and previous meeting minutes, and any information required to make decisions on proposed topics before the meeting and between meetings if necessary. All members must receive the same information simultaneously. Members bear personal responsibility for following up, ensuring receipt of adequate and appropriate information, and studying it carefully.
7. Meeting draft minutes reflecting conclusions must be distributed within seven days of the meeting date, signed by all board members with each member's signature date. Signed minutes of each Board meeting must be provided to the Monetary Authority within one month of the meeting date.
8. The Board may summon necessary experts and consultants to Board meetings to obtain their opinions on topics the Board deems necessary, and may request technical and legal advice at the institution's expense as the Board decides.
9. The Board must balance its role and responsibilities with executive management's role, ensuring executive management does not make strategic decisions that fall within the Board's core functions.
10. The Board should encourage executive management's participation in discussing topics presented for study before the Board, and the participation of senior executives whose work nature requires it in Board meetings, or to prepare specific individuals for senior executive positions in the institution.

6.2 Principle Two: Board Member Qualifications and Composition

The Board is the institution's primary representative, reflecting its image to society and official and regulatory authorities. This requires board members to possess appropriate qualities, capabilities, and training to perform their assigned roles and bear governance and risk management responsibilities. Board independence from executive management is essential and necessary. A Board selected by executive management is characterized by weakness and lack of independence.

Conditions Required for Board Members:

1. Board members must possess personal qualities qualifying them to represent the institution and serve as positive role models for all employees, such as integrity, uprightness, and good reputation.
2. Board members must possess appropriate practical experience suitable for specialized lending institutions' operations.
3. The Board must collectively possess appropriate knowledge and experience in all financial, developmental, and social activities related to specialized lending institutions' operations.
4. The Board must have the ability to understand the business environment and the legal and regulatory environment in which the institution operates.
5. The Board must have the ability to formulate policies, plans, and strategies.
6. The majority of board members must hold at least a bachelor's degree in economics, business administration, or related fields, and possess good knowledge of developmental topics that form the basis of specialized lending institutions' operations.
7. A board member must not be less than twenty-five years old at the time of nomination.
8. Must meet the conditions specified by the Monetary Authority pursuant to relevant instructions.
9. No person may serve on the Board unless they meet the following conditions: a. Have not been convicted by a final court judgment for crimes of theft, fraud, embezzlement, forgery, defamation, bribery, misappropriation, crimes violating honor and public morals, or money laundering crimes, unless their reputation has been restored. b. Have not caused the collapse or serious loss of a specialized lending institution, a bank, or any other institution where they served as a senior executive, chairman, or board member. c. Have not declared bankruptcy or been unable to pay debts, becoming insolvent. d. Have not been dismissed by another regulatory authority, unless with prior approval from the Monetary Authority according to its assessments. e. If the institution's Board of Directors requests the removal of the chairman or a board member for justified reasons to protect the institution's interest. f. If they violated the Banks Law or the licensing and supervision system for specialized lending institutions, or instructions issued thereunder, and their violation exposed the institution to serious risks.
10. The Monetary Authority has the right to issue a decision to dismiss a board member, any senior executive, or employee in the specialized lending institution in the cases mentioned in Article (9) of Principle Two, Section One.

Board Composition:

1. Board composition requires prior Monetary Authority approval for the chairman and members.
2. The majority of board members must be permanent residents of Palestine. Otherwise, prior written approval from the Monetary Authority is required.
3. The number of board members must be proportional to the institution's size and its need to form multiple committees, with no fewer than five members.
4. The Board must be composed of members with diverse backgrounds in financial, banking, economic, administrative matters, and issues related to the developmental dimension of institutions.
5. The Board must operate completely independently from senior executive management, enabling independent decision-making. The Chairman or any member must not hold any executive position in the institution, paid or unpaid, during the Board term they serve, or for two subsequent terms after the Board's term ends, without prior Monetary Authority approval.
6. The Chairman and board members, including representatives of legal entities, must not serve on the board of directors, as senior executives, or as employees in another institution or public bank operating in Palestine without prior written Monetary Authority approval.
7. The Chairman and board members of non-profit institutions may not be elected for more than two consecutive terms.
8. The Chairman or any board member must not be individually authorized to exercise part or all of the Board's authorities.
9. The Board must, as much as possible, avoid the presence of a controlling group in the Board and avoid adopting procedures that create a conflict of interest. The Board must adopt policies and mechanisms to identify and assess the likelihood of conflicts of interest, ensuring all board members and senior executives disclose information regarding the existence or possibility of a conflict between their interests and the institution's interests, and update this information periodically. In the case of a controlling group, their voting power in the Board must not exceed one-third of the votes.
10. The Board must include at least one independent member, unless there is no person or controlling group of shareholders in the Board. If a person or controlling group of shareholders exists in the Board, it must include at least two independent members.
11. The Board must regularly review its composition as part of its annual performance evaluation and recommend to the General Assembly any amendments or additions it deems appropriate.

6.3 Principle Three: Board Committees

Given the nature of the Board's work and the periodicity of its meetings, and to assist the Board in performing its duties without relieving the Board of responsibility for its committees' work, the Board must form committees, at a minimum: the Audit and Risk Committee, the Governance and Nomination Committee, the Assets and Liabilities Management Committee, and the Social Performance Monitoring Committee. The Board may form any other committees as required by operational interests.

General Rules Regarding Committees:

1. Committees are formed by a Board resolution specifying the committee's chairperson.
2. Prior Monetary Authority approval must be obtained for the formation of committees and their duties.
3. Each committee must have an approved charter by the Board defining its duties, responsibilities, and operating mechanism.
4. Committees must document their meeting minutes, including all discussed matters and all their activities. Meeting minutes must be signed by all attending members.
5. The Board's responsibility remains in effect. Forming these committees does not relieve the Board of its duties, as these committees are formed solely to assist the Board. Board approval of committee recommendations constitutes binding decisions.
6. Each committee must have the necessary resources and authorities to perform its duties and responsibilities.
7. Each committee must present and review its annual performance evaluation with the Board, comparing it to the specific tasks and requirements of each, and provide recommendations to the Board's annual meeting regarding improvements deemed necessary or required in its charter.
8. Some committees may be merged based on the nature and size of the institution, number of board members, and subject to prior request and Monetary Authority approval, provided the Audit and Risk Committee and the Assets and Liabilities Management Committee remain