The challenges confronting bank directors are coming from every direction. The public is angry about the bailout and hefty bonuses, and shareholders are angry about poor risk management. Politicians want more lending and oversight, and regulators want more caution and deference.

To make matters worse, these demands often conflict. How is a bank expected to increase lending and its capital cushion at the same time in a weak economic environment? How is it expected to lure and retain the talent necessary to survive when pay is being dissected by the media?

If the financial crisis taught directors anything, it's that, no matter what size the bank, they must exercise tighter control over management and be actively engaged in setting strategic direction.

Unfortunately, the crisis also revealed how poorly equipped many bank directors are to do this. They often lack financial services experience and sometimes even business experience. And some are so close to top executives that they are reluctant to challenge decisions-even bad ones.

Nell Minow, the editor and co-founder of the Corporate Library, a corporate governance research firm, says boards are as accountable as management for the banking industry's problems and now must take seriously the "slow, painful process of rebuilding trust with shareholders."

They can start by taking a tougher stance on compensation policies, she says. Directors "have been enablers of outrageous pay packages and they need to stop."

They also need to bone up on accounting, finance, regulation and risk management, all while working with management to help grow their banks and build value.

It's a lot to tackle, to be sure. Following are what experts see as the top five issues facing directors.

1. BOARD COMPOSITION

Most bank boards have had little turnover since the financial crisis began, even though many directors showed poor leadership."That so many are still on the boards of these banks is outrageous," Minow says.

The Cambridge Winter Center for Financial Institutions Policy cites three ways to improve boards. First, increase the percentage of outside directors who have financial services experience. Second, reduce the size of bank boards to create more accountability. Third, and perhaps most controversial, pay board members better.

According to a Cambridge Winter survey, in the second quarter of 2009 just 22 percent of directors at large banks were outsiders with financial services experience. Minow says such figures are astonishing. "Everyone needs to understand financial reporting and bank regulations," she says. "Diversity does not mean someone who doesn't know anything about banking."

The survey found that big bank boards have an average of 14 members, compared to 12 at nonbanks. What's more, large banks actually pay their directors one-third less than what large companies in other industries pay their directors. The average director compensation at 17 of the 19 companies subject to federal regulators' stress tests last year was $209,000, which seems, "to most observers, more than adequate pay for what is, after all, a part-time job," the report says. "But, ironically, it may well be too low for the job that bank shareholders actually need directors to do-providing an active, grounded substantive check on management."

Recently banks have had some success reconfiguring boards. A year ago only 11 percent of Bank of America's board members were outside directors with financial services experience, but by October that figure had jumped to 38 percent, thanks to pressure from shareholders and the Treasury Department. And in February, Citigroup continued a slower remaking of its board. It announced that it would shrink its board from 17 to 15 and add former Mexico President Ernesto Zedillo to help structure its non-U.S. operations.

Some smaller banks also are shrinking their boards and having their own executives step down, to reduce the influence of insiders. After appointing an independent lead director last year, Green Bankshares in Tennessee announced in March that regional executive Ronald Mayberry would not run for re-election when his term expires in April. A director since 2003, Mayberrysaid his decision reduces the number of inside directors on the board, "further fortifying our strong corporate governance practices."

2. COMPENSATION

Directors are under intense pressure to rework compensation policies to reward good behavior and keep talent, but not encourage too much risk-taking and short-term thinking. They also must deal with regulators, who have become increasingly vocal about how banks should-and should not-compensate their executives. In fact, boards that do not overhaul compensation plans when a regulator asks expose themselves to civil money penalties.

A report by Amalfi Consulting summarized three broad principles outlined by the Federal Reserve Board to ensure that incentive compensation arrangements do not encourage employees to be too aggressive. First, these arrangements should balance risk and financial results in a manner that does not reward employees for taking excessive risks. Second, risk-management processes and internal controls should help ensure balance with incentives. Third, banks should have strong corporate governance.

In the past, compensation committees set performance pay based primarily on metrics such as return on equity, return on assets and earnings per share. But going forward, they are likely to add elements such as capital levels and credit quality. Banks also are adjusting timelines so that executives cannot make immediate gains without regard to long-term negative effects. Such tactics include converting cash bonuses to deferred stock and instituting clawbacks to allow for recouping bonuses from employeesif their decisions later prove too risky.

Susie VanHuss, chairman of the compensation committee at SCBT Financial Corp. in Columbia, S.C., told Bank Director magazine that earnings-per-share increases remain important, "but right now, we don't want too much growth with the kind of risk you'd have to take to get it." Asset growth, once a factor, has been removed for now from the executive pay formula, she says, while tangible common equity levels, CAMELs ratings and asset-quality measures have been added.

3. RISK MANAGEMENT

Joseph V. Rizzi, a senior investment strategist at the New York private equity firm CapGen Financial Group, wrote in a commentary for American Banker that directors have "failed to appreciate or contain" the risks bank executives were taking. He says banks should require that independent committees-not management-recruit, retain and remunerate directors; and empower risk management by appointing a chief risk officer that reports to an independent board member.

Many boards are taking steps to set up a healthier risk culture, create reporting structures to better oversee management, and implement new technologies to better quantify and analyze enterprise risk. (Enterprise risk is normally considered to be a combination of credit risk, interest rate risk, liquidity risk, market risk and operational risk).

Enterprise-level risk management also demands top-notch technology tools. But according to a survey of global financial institutions by Oliver Wyman and the Risk Management Association, until recently there's been "a chronic under-investment in data management, analytics, and people dedicated to an integrated view of the businesses." That might be changing. In a December study of North American retail banks by Ovum, 61 percent said they expect to increase spending on technology for risk management.

Also, more boards have gotten serious about appointing experienced chief risk officers. Huntington Bancshares hired Kevin Blakely as chief risk officer last year. He had served at the RMA and managed risk at KeyCorp.

4. PERSONAL LIABILITY

Regulators are getting more aggressive about assessing civil penalties against individual directors for a bank's performance, an unnerving possibility that few directors considered when they joined boards. While standard D&O insurance typically covers shareholder lawsuits, the real danger comes when regulators levy penalties based on their interpretation of the "standard of care" in the jurisdiction in which the bank is based. These fines are generally not covered by insurance, and typically range from $5,000 to $250,000, says Jeff Gerrish, chairman of Gerrish McCreary Smith Consultants in Memphis.

Most liability claims will be based on loans that "never should have been made" had the directors been doing their jobs, Gerrish wrote recently on his blog. To fend off such lawsuits directors must prove that their reliance on management to make these loans was reasonable; however, "if they received criticism of management or the credit administration function of the bank," and did nothing, then, arguably, their reliance was not reasonable, he says.

Directors who want to determine their exposure should understand the standard of care and assess their conduct in view of that standard. Another factor for regulators in deciding whether to pursue a director legally is determining if there would be any recovery available. But directors can insure themselves against such a possibility; they can get a policy covering their portion of a civil money penalty or pay for such coverage on the bank's policy.

5. KNOW WHEN TO QUIT

Given how many board members do not have the skills or time to be truly engaged, it's critical that individual directors frankly assess their own talents and contributions to a board. David Baris, executive director of the American Association of Bank Directors, says, "If you're consistently out voted; if you disagree with the direction of the bank; if you're not satisfied with management and management has not changed even after your urging; generally, if you're ineffectual, it might be time to resign."

That was the conclusion of Robert Schweiger, who resigned in January from the board of the struggling $253 million-asset FPB Bancorp in Port St. Lucie, Fla. In his resignation letter, Schweiger said he lacked confidence that the management can protect shareholder value, maintain proper capital levels and manage assets. He also lacked confidence in the board's ability to direct management effectively.

To help directors educate and evaluate themselves the AABD and other banking trade groups offer workshops. The AABD also offers questionnaires to help individuals judge their own qualifications as a director.

However, Baris advises against concocting reasons to quit-such as the fear of liability. "What has happened has happened, and if you believe you can contribute to the health of the bank, that's a good reason to stay."

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