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Banks Should Reject More Board Candidates

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Former directors of the nearly 3,500 U.S. financial institutions that have failed since the mid-80s must appreciate Groucho Marx's letter of resignation from the Friars Club in 1949: "I don't want to belong to any club that would accept me as one of its members."

The proverbial Bank Directors Club of America is not as exclusive as you might think. In a nation of 7,246 financial institutions, the club has roughly 94,000 members.

How many are qualified to be a bank director?The answer may surprise you.

They all are.

How do I know? Take a look at the requirements for the job according to the Office of the Comptroller of the Currency.

The Director's Book lists six qualifications to be a national bank director.  The list includes these five requirements: "basic knowledge of the banking industry," "a willingness to put the interests of the bank ahead of personal interests," "a willingness to avoid conflicts of interest," "knowledge of the communities," and "a willingness to … commit the time."  There is a sixth qualification: "background, knowledge and experience in business or another discipline to oversee the bank." 

In other words, if someone has the time and is honest, they are qualified to be a director of a U.S. bank. 

Standards and testing for "basic knowledge" do not exist.  Individual banks' board nominating committees presumably establish their own definition and test. Let's ask the question about directors another way: How many of the 94,000 are truly qualified to be directors?

To answer this question, it is useful to examine lessons learned from failed banks.  The 457 banks that have failed in the U.S. since mid-2006 provide keen insights about director qualifications.

According to the Federal Deposit Insurance Corp., 665 director and officer professional liability lawsuits tied to 80 banks have been authorized since 2009. Of that total, 40% were authorized in 2011 and 44% in 2012 through October 12th. The FDIC notes that "professionals may be sued for either gross or simple negligence."

That statement raises several questions.  Does America have "professional" bank directors?  What is a "professional" director?  Is the term even defined?

A close examination of the FDIC's 98 Material Loss Reviews – which are basically these failed banks' autopsy reports – provides clues as to what is expected of professional directors.  In 97 of the 98 MLRs written by the FDIC, ineffective bank directors are identified as a primary cause of bank failure. (The one exception, inexplicably, is 1st Centennial Bank in California.) 

One MLR is especially helpful in describing the responsibilities of a bank director.  From the Imperial Bank MLR the FDIC writes: "An institution's Board is responsible for establishing appropriate risk limits, monitoring exposure and evaluating the effectiveness of the institution's efforts to manage and control risk."

Is it reasonable to expect someone with "basic knowledge" of banking and "experience in business or another discipline" to set bank risk limits, monitor exposure and judge management's risk controls? Having spent 31 years in banking, my professional opinion is that it is unreasonable and unfair to expect someone with basic knowledge of banking to meet the FDIC's standard for director qualifications.

I have reviewed board data for 430 U.S. banks of all sizes. My conclusion: The director selection model for too many U.S. banks does not reflect the industry's risk profile realities of 2012.

Despite our nation's history of high bank failure rates, we see little evidence that director selection has evolved from the 1950s era of "paint-by-number" banking. Back then, interest rates were regulated, net interest margins were guaranteed and lending policies were overseen by bankers who survived the Great Depression. None of that is true today.

For good reason, Citigroup's board has been transformed since 2007 when it was a Who's Who of Fortune 50 CEOs. Today, only one director predates 2007. Seven of the 11 outside directors have substantial experience in banking, bank supervision and financial oversight.

In contrast, consider the boards of 37 banks with assets between $10 billion and $299 billion. Of the 476 directors, 16% are bank executives. Non-executive directors include 6% with commercial banking backgrounds and 1% with regulatory experience.  Another 9% are from private equity/investments, 7% are lawyers and 9% are CPAs/CFOs. More than half (52%) of the directors have business, academic and non-profit experience outside of banking or investments.

Is it possible the U.S. banking system suffers from a severe shortage of directors with the hands-on experience and formal training to govern our banks? 

Every 20 to 25 years we seem to be reminded that banking is a tough business. Directors would serve their investors well by clearly documenting their qualifications to form bank strategy, set risk limits and monitor controls. 

The Bank Directors Club needs to be more exclusive. Unqualified directors would be wise to heed Groucho Marx's counsel.

Richard J. Parsons spent 31 years in banking. He now writes about the industry.  His book, "Broke: America's Banking System," will be published by The Risk Management Association in spring 2013.

 

 

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Comments (2)
Editor's note: The author, Richard J. Parsons, should not be confused with Richard D. Parsons, the former chairman of Citigroup.
Posted by Marc Hochstein, Executive Editor, American Banker | Friday, October 19 2012 at 2:47PM ET
Your point about Citi groups new is mute. The only reason they replaced their board is because for the third time in the last 30 years, they again failed. If they were not "too big to fail", you would not even be able to reference their new board members, but only talk of the deriliction of duties of the past board.
Posted by dahlers | Friday, October 19 2012 at 3:24PM ET
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