I've seen up close hundreds if not thousands of troubled financial institutions over the years and have drawn some conclusions about governance that I would like to share:
- Banks don't make bad decisions, people do. A bank, like any corporation, is a legal fiction. Prior to my time as chairman of the FDIC, regulators took enforcement actions against banks but rarely against the people running them.
- There is a high correlation between problem banks and dominant chief executives with compliant boards of directors. Banks need experienced, independent and involved directors to test management's assumptions and ensure that careful thought has been given to the risks of a given strategy. It is management's job to run the company, but the strategies, business plans and outcomes require vigilant and constructive board oversight.
- A board should have and select its own leadership and membership with input from the chief executive. I've been a proponent for many years of separating the roles of the chief executive and the chairman. I believe the separation empowers the board to provide better oversight.
- The structure, composition, and mandate of the board committees are exceptionally important, particularly as banks become larger and more complex. I was appointed chairman of Fifth Third Bancorp about nine months ago. I decided, as part of my own education process, that I would attend as many board committee meetings as possible. I was glad I did, and I came away very impressed with the hard work and dedication of the committees. They are each conducting specialized board meetings and taking deeper dives into their subject matters than can be done by the board itself. I don't know how you can oversee a bank of size today without a robust board committee process.
- Board materials, at least in larger banks, need to be relatively high-level and big-picture-oriented. Many banks inundate board members with information — I guess on the theory that more is better and in any event will make regulators happier. Most board members have busy professional and personal lives. They have limited time to sift through reams of facts and data to find what is important. Management should work with the board to develop an effective way to reflect the bank's condition and risks, the results of its operations, and its challenges.
- The past is past and cannot be changed, so boards should focus more on the present and future. The primary reason to look back is to learn lessons — what mistakes were made and what went right. While management and boards should do that every now and again, most board meetings should be focused on the here and now and the road ahead.
- Management of risk is without question the critical difference between success and failure in banking and should receive a good deal of attention from the board and its committees. The primary way to manage risk is to diversify. Early in my career I was with a regional bank that enjoyed over 40 consecutive years of increased earnings and dividends. The chief executive, in explaining this remarkable record, said: "We're not smarter than other banks, and we have in fact made every dumb mistake they have made. But we don't make big bets, so when we make a mistake we can absorb it and move on." Banks need to understand their risks and how they are or might be correlated. The larger and more complex the bank, the more investment it will need to make in high-quality, forward-looking risk management processes.
- You get what you pay for. I have two things in mind when I say this. First, the bank director's job is significantly more demanding than ever. It requires a greater time commitment and range of skills. For a bank to attract high-quality directors, it must compensate directors fairly for their time and legal exposure. Second, management compensation is extremely important and requires careful consideration by the board and its compensation committee. If a bank pays for loan production, it will get that production for good or ill. If a bank pays for short-term earnings growth, it will likely get short-term earnings growth even if it turns out not to be in the long-term best interests of the company.
That dynamic has changed, and many regulatory orders contain requirements for independent reviews of the board and management. Moreover, directors and officers face personal exposure to liability and need to take their jobs very seriously.
I hear two primary arguments against this approach: it could lead to friction or confusion between the chairman and the chief executive; and it could be seen as diminishing the role of the chief executive. These concerns can be easily addressed by selecting the right people for the two roles, clearly defining the roles which are quite different and maintaining good communication between the chief executive and the chairman. Regulators should encourage all larger banks to adopt this model. The FDIC could consider making board governance a factor in determining risk-based insurance premiums.
Banks that get governance right will have much better odds of success in any economic climate. Conversely, if a bank is experiencing serious problems the governance process needs attention.
