Although notable improvements are being made in corporate governance at emerging market banks, the effectiveness of the new governance codes’ implementation will only be tested in an economic downturn, according to Fitch Ratings.

In a special report issued Thursday, Fitch notes that weak corporate governance practices at any company are a negative rating factor and may serve as a cap on how high a rating can go, however strong its financial profile may seem.

The degree of governance in companies goes hand-in-hand with the level of political governance in a country, and development of good corporate governance in banks often runs in tandem with progress in risk management controls and regulation, it adds. In the report, Fitch assesses corporate governance in various emerging market banking systems, how this is developing and the impact this has on the ratings.

“The establishment of good corporate governance codes on their own may not make very much difference to poor governance in practice. Implementation is key,” says Bridget Gandy, head of accounting and corporate governance research at Fitch and co-author of the report. “Corporate governance requires a separation of function between the board, executive management and audit. The independence and authority of each function needs to exist in more than only legal form. Fitch has seen progress in implementation in most emerging markets over the past two years.”

Fitch notes that the most prevalent weaknesses in governance in emerging markets are a high level of related-party influence (a consequence of wealth and power being concentrated in only a few hands) and an absence of challenges to the status quo due to lack of experience and expertise. State ownership of the banks and/or direct influence on their operations is a major issue that can taint governance.

In spite of a general improvement, there is still room for progress and weak corporate governance remains a constraint on Fitch’s ratings for a number of banks in emerging markets, it reports. Ratings for these will only be upgraded once tangible improvement in corporate governance becomes evident. However, as improvement in corporate governance generally goes hand-in-hand with more general improvement in risk and business management, it is rarely possible to pinpoint the impact of corporate governance alone on a rating.