11th September, 2020Jeremy Denton-Clark

Common Governance Issues Facing the Board of Directors of Banks

1. All the boxes are ticked but often it doesn’t actually happen, things just go along more or less as they have always done.

There needs to a governance culture in place. Shareholders, directors and executives should understand that decisions for building long term stability and value are best made according to a structure and a methodology and not according to the views of one or two people. No one person can understand all there is to know about running a bank, there is too much.

It comes down to building trust, a willingness to delegate and confidence in the judgement of other committees, people and departments within the bank. A lot of this comes down to the nomination, assessment, appointment, remuneration and evaluation procedures.

2. The shareholders need to understand why they are there and what they can do and what they should not do.

There is also the need for the governance of the bank to balance the wish of the shareholders to maximise profitability and the share price with the need of the other stakeholders of the bank to maintain stability and conservative capital and liquidity ratios.

A continual drive towards increased quarterly profitability and the share price can result in the bank accepting risks that it would not normally take. The Board of Directors need to define the Risk Appetite of the Bank for the guidance of the executive management and not push for unrealistic profit targets

3. Establishing the balance of authority within the bank.

Sadly there is amongst some people a tendency to accumulate power and authority over others, this may not be obvious and indeed probably isn’t an issue for most people but in financial institutions that handle large sums of money it can be more of a temptation. It has to be resisted through the requirement for strong and active corporate governance.

A primary objective of corporate governance is to balance power and authority within the bank so each unit knows its place, role and authority within the structure and isn’t tempted to infringe upon the role of others, for example independent non-conflicting nomination, assessment and appointment procedures for Board members and senior executives.

4. Expressing an independent view when you are part of the team is hard to do and can put your livelihood at risk.

The issue is that it is the responsibility of the gatekeepers to take the side of the bank and all of its stakeholders. This means that from time to time they have to say “no” to the business
development and income generating divisions of the bank. This also usually hits the potential bonus of the business development officers.

The Risk Management Division, the Compliance Department, the Internal Audit Department are ultimately dependent on the executive management of the bank for their salary and bonus structure, career path as well as the provision of their support staff and premises. They are thus aware that if they are overly diligent it may have a negative effect upon their career and progress within the bank.

A fundamental requirement of Corporate Governance is to maintain that independence without stifling the business and profitability of the bank.

5. Banking technicalities are going beyond what many senior bankers can reasonably be expected to make an informed decision.

As the world becomes more complicated and regulated, no one person can be expected to understand all the fine detail of Basel III and IV, IFRS 9, FATCA and so on let alone IT and cyber-crime. The risk being that the Board of Directors or even the executive are being “blinded by the science” and miss some of the consequences of their decision.

This infers that decision making needs to be delegated, often to committees and these committees need to bring in experts from outside the bank to provide professional expertise on their particular subjects, the Audit Committee would be a good example.

6. What keeps bankers awake at night?

Probably the greatest worry is cyber-crime and data theft. Whilst it is always going to be expensive, the greater threat is that depositors will lose trust in the bank keeping their money and data safe and confidential. This can lead to a liquidity shortfall, possibly within hours. The Corporate Governance question facing Boards is how do they put in place a structure that mitigates the risk in the first place but then is able to respond immediately?

Failure to do so might be construed by creditors in a liquidation as a dereliction of the fiduciary duty of care by the Board of Directors.

7. Are you quite sure the bank isn’t trading wrongfully?

In most jurisdictions it is a criminal offence should the bank be trading whilst putting its creditors and assets at risk. Most Boards of Directors will recognise that paying substantial dividends to shareholders whilst the prudential rations are under pressure could amount to mismanagement and a breach of their duty of care to all the stakeholders.

However, underlying problems are not always quite so self-evident. For example the bank may have for many years been dependent for a significant part of its liquidity upon bidding for deposits from other banks or major institutions. This like all other deposits is dependent upon the confidence of the depositor that they will be repaid. Large deposits are likely to be outside any existing deposit protection scheme and any flutter in confidence could result in the immediate withdrawal of a large slice of the liquidity of the bank. In retrospect creditors may look back and say the bank was wrongfully trading.

Another example might be the level of provisioning for the Non Performing Loans of the bank. Nobody has an interest in bringing bad news to the attention of management and the Board of Directors. A bad loan is an admission of failure, the responsible loan officer may want to protect their bonus (and thus might be tempted to extend the period of the loan to bring it current), Internal Audit Department rarely have the expertise nor gumption to challenge individual provisions and the external auditors want to be reappointed for next year’s audit.

8. Personal liability of members of the Board of Directors

When things go pear shaped in a bank, everybody can become a target. Creditors are likely to be particularly aggrieved, depositing with a bank is supposed to be risk free. The first place they are going to look is to see if the directors knew or should have known if the company was entering into transactions when there was a danger of becoming insolvent.

Assuming there have been no intentional wrongful acts, it may be sensible for the bank to take out Directors and Officers Liability Insurance to cover the defence costs of directors and executives who may be attacked for doing what they considered at the time to be in the best interests of the bank and its stakeholders.

9. Building values with an Environmental, Social & Governance Code

To reflect the global concerns about environmental protection and climate change, the bank may well be required to develop an ESG Code requiring provisions on such matters as:

• Environmental criteria: Compliance with national and – if possible – international environmental standards, energy consumption, water utilisation and discharge, waste disposal, pollution discharge, greenhouse emissions, conservation of national resources, animal welfare and so forth.
• Social Criteria: treatment of employees, suppliers, customers and the wider community. It would also cover health and safety at work, training and education, fighting corruption, payment of a living wage, the absence of all discrimination etc.

These would be additional to the standard governance provisions relating to the structure and functioning of the Board of Directors, internal controls, internal audit, risk governance, compliance, disclosure, transparency and so forth.

10. The ESG Code needs to be regularly up-dated and transparent.

Not unreasonably shareholders, depositors, creditors and all other stakeholders, including the staff, expect the bank to be prudently and conservatively run in accordance with the best international standards of Environmental, Social and Governance. These are evolving all the time and people like the international rating agencies will expect to see them and regulatory authorities will seek to ensure that they are applied in practice.

It makes sense for the ESG Code to be reviewed on an annual basis by a committee of the Board of Directors, for the ESG requirements to be fully set out and explained in the Annual Report and for compliance to be part of the assessment of the individual directors and executive management.