Internal Controls and Credit Risk in European Banking: The Basel Committee on Banking Supervision Framework Approach

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.

Analysis of the Internal Control System on the Revenue Cycle of Lending at Rural Bank

“…An effective internal control system is an important component in bank management and is the basis for healthy and safe financial operations. Research conducted on banking in Spain shows a significant effect of internal control on credit risk [1]. Internal control is a supervisory mechanism established by management on an ongoing basis, with a purpose [8] Weak internal control systems in banking institutions can have an impact on the operation of a bank [8], supervisory mechanisms become weak and bank management accountability mechanisms become unclear which can result in a culture of internal control at all levels becoming non-occurring.…”

“…This role is carried out by providing loans that have the potential to increase credit risk. Credit risk is crucial for bank management because of its relationship with other risks such as operational, market, and liquidity risks [1]. The problem that arises if credit risk is not prevented is bad credit.…”