Board Independence and a Related-Party Loan
Halima Bank has a seven-member board: a non-executive chair, the CEO, the CFO, and four non-executive directors. One non-executive director, Mr. Otieno, chairs the audit committee and also sits on the credit committee. The bank is considering a KES 120m loan to Zawadi Traders Ltd. Mr. Otieno's cousin owns 35% of Zawadi; the cousin is not a director of the bank. The CEO supports the loan, noting Zawadi's strong financials and a 40% deposit. The credit committee is due to vote next week. Separately, the audit committee has flagged that the CFO approved a KES 9m payment to a supplier without a contract, and the CEO has asked the audit committee to 'leave it to management'. The bank's policy defines a related party as any director, senior manager, or their immediate family members, and is silent on cousins.
1. Advise on how Mr. Otieno and the board should handle the Zawadi loan, including committee composition and voting.
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Is it a related-party transaction?
- Under the letter of the policy, a cousin is not an immediate family member, so the loan may not be captured.
- Under the spirit - and under good governance - a close relative with a 35% stake creates a potential conflict of interest that must be managed, even if it falls outside the technical definition.
What Mr. Otieno should do
- Declare the interest in writing to the board and the company secretary, before any discussion.
- Recuse himself from the credit committee's deliberations and vote on this facility.
- Step out of the audit committee's oversight of the transaction if the audit committee reviews related-party disclosures.
What the board should do
- The credit committee should vote without Mr. Otieno. If his recusal leaves the committee without a quorum, the matter goes to the full board, again without him.
- Apply the arm's-length test: the loan terms must be no more favourable than those offered to an unrelated borrower of similar risk. Document the comparison.
- Disclose the interest in the related-party register and, if material, in the financial statements.
- Fix the policy: extend the definition to close family members and entities in which directors or close family have a significant interest. Silence in a policy is not permission.
Governance principle Substance over form. A policy gap does not remove the ethical obligation; it exposes the board to criticism for exploiting it.
2. How should the board respond to the CEO's request that the audit committee 'leave it to management' on the KES 9m payment?
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The request is improper The audit committee exists to provide independent oversight of management, including the CEO. A CEO cannot instruct the audit committee to stand down - that inverts the accountability relationship and, if accepted, would compromise the committee's independence.
Why the payment matters
- KES 9m paid without a contract is a control failure: no evidence of an enforceable obligation, no agreed price, no delivery terms.
- It may indicate: a breakdown in procurement controls, an unauthorised commitment, or potentially fraud. The audit committee cannot know which without investigating.
- Even if innocent, the absence of a contract means the bank may have no legal recourse if the supplier fails to deliver.
Recommended response
- The audit committee chair (or another independent member, given Mr. Otieno's position) formally responds to the CEO: the matter is within the committee's mandate and will be reviewed.
- Investigate: obtain the supplier file, approvals, bank details, and evidence of goods/services received. Check whether the supplier is connected to any employee.
- Report to the board (and to the board risk committee), not just to the CEO.
- Escalate externally if fraud is indicated - to the regulator and, where required, law enforcement.
- Remediate controls: mandatory contract before payment, segregation of duties, dual authorisation above a threshold.
Governance principle The audit committee reports to the board and, ultimately, to shareholders and the regulator. Its independence is only real if it can say 'no' to the CEO. If the CEO's request is repeated or pressure continues, that itself is a governance matter for the board chair.
3. What structural changes would you recommend to the board's composition and committees?
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Composition issues
- Seven members with two executives (CEO, CFO) leaves five non-executives - acceptable in number, but independence must be tested, not assumed.
- Mr. Otieno sits on both audit and credit committees. This is a concentration of oversight. The audit committee must be independent of credit decisions it may later have to scrutinise.
Recommendations
- Separate the roles: Mr. Otieno should not sit on the credit committee while chairing audit. Choose one; audit is the more sensitive.
- Audit committee composition: all independent non-executives, with at least one financial expert. No executive members.
- Credit committee: should not include the CEO as a voting member on related-party matters; the CEO should present and withdraw.
- Chair independence: the chair should be independent of management and not the CEO. Confirm this.
- Related-party policy: broaden the definition; require annual declarations of interest from all directors and senior managers; maintain a register.
- Whistleblowing and escalation: ensure a channel that bypasses the CEO.
- Board evaluation: annual, covering committee effectiveness and independence.
Principle Good governance is not about having the right titles; it is about ensuring that no single person can both make a decision and judge it. The current structure lets Mr. Otieno influence credit and then audit it - and lets the CEO direct the audit committee. Both should be closed.