How much should a bank board know?
WASHINGTON — The Federal Reserve’s plan to change the rules regarding the responsibility of banks' boards of directors has sparked a debate about what the boards' role should be in supervisory matters.
The central bank published a pair of proposals Aug. 3 that reversed 2013 guidance elevating certain matters to the board for approval and codifying a rating system for various aspects of board efficacy. The Fed said that the changes were the result of a yearslong review of its guidance, but some critics say the move gives the appearance of easing the Fed’s oversight at a time when boards are under increasing scrutiny.
"It is potentially a pretty dramatic change in the way the Fed supervises bank boards and management,” said Dennis Kelleher, president of the public advocacy group Better Markets. “There is nothing more important to boards of directors than authoritative information on what is happening at the institution. [This is] valuable information that any board worth a whit should want.”
But the Fed and industry representatives say the changes effectively eliminate a load of busywork from boards’ agendas, allowing them to focus more on critical issues. Federal Reserve Gov. Jerome Powell, who heads the agency’s supervisory committee, said the changes do nothing to reduce a board’s supervisory responsibilities, but rather sharpen them and distinguish them from management's responsibilities.
“This is actually the first time we will be highlighting the performance of the board separate from senior management,” Powell said. “We’re increasing the focus on the board and clarifying our expectations of them in a way that we hadn’t before, and in a way that makes it easier to hold them accountable. We’re not downgrading it, we’re upgrading it.”
The first proposal would recast the Fed’s supervisory expectations and rescind existing guidance regarding supervisory Matters Requiring Attention and Matters Requiring Immediate Attention (MRAs and MRIAs), effectively redirecting those items to senior management rather than boards of directors. Those changes would apply to all banks, while the supervisory expectations guidance would primarily apply to banks with more than $50 billion in assets.
The second proposal is a new rating system that would set out assessments for each individual bank’s capital planning and positions, liquidity risk management and positions, and governance and controls. That system would apply only to banks with more than $50 billion in assets and nonbanks designated as systemically risky.
Bank boards have long complained that longstanding Fed guidance has stipulated that MRAs and MRIAs are immediately elevated to the board level, and the accumulation of those matters essentially results in a pro forma review by board members, who in most cases are not experts in the issue at hand and tend to defer to the expertise of whoever is briefing them.
Greg Baer, president of the Clearing House Association, said that boards of directors exist in order to perform certain functions, including overseeing senior management, controlling risk appetite, devising strategy, considering succession of management and ensuring compliance. Spending a disproportionate share of their time on issues on which they have little expertise takes away from time they could spend in areas where they could help run the bank, he said.
“When it comes to your average MRA, there’s not going to be any meaningful input from the board of directors,” Baer said. “It makes all the sense in the world to shift their finite resources from areas where they can add no value to areas where they can add considerable value.”
But Kelleher said that MRAs — and especially MRIAs — are not routine supervisory information, but rather precisely the sort of data that a board of directors should acknowledge if a bank is going to be expected to avoid the kind of systemic mismanagement that boards of directors were complicit in leading up to the financial crisis.
"If a bank has so many MRAs and MRIAs that it’s a burden for the board of directors, then there’s a bigger problem going on," Kelleher said. "There’s no indication that the Fed did any deep thinking into what led to the dereliction of duty … that led up to 2008."
Marcus Stanley, policy director for Americans for Financial Reform, said he agrees that boards should not waste their time, but he is concerned that the proposal doesn’t balance the need for boards to work effectively with the need of bank supervisors and internal risk managers to get attention when something is amiss.
“In principle, you can’t really argue too much with the idea that what the board spends its time on should be prioritized, and they shouldn’t be flooded with every single little thing,” Stanley said. “But the ability to get senior management’s full attention depends on access to the board. So this could really end up fitting in with this agenda to … resist demands for better risk management.”
The proposal also comes as the Fed is facing competing pressures from lawmakers about its oversight of bank boards.
Sen. Elizabeth Warren, D-Mass., sent a letter to Fed Chair Janet Yellen in June demanding the removal of most of Wells Fargo’s board of directors in response to their failure to anticipate and respond to the cross-selling scandal that embroiled the bank last fall. The bank shook up its management last week, naming former Fed Gov. Elizabeth “Betsy” Duke as chair of the bank’s board beginning in January and replacing three of the remaining board members.
But others are calling on the Fed to be even less severe in its examination of bank boards. During Yellen’s testimony before the House Financial Services Committee last month, Rep. Sean Duffy, R-Wis., questioned Yellen about whether members of the Fed board, like members of a corporate board, have fiduciary responsibilities to a bank’s shareholders. Yellen confirmed that they do not.
“You do have a supervisory role and I want you to do a good job,” Duffy said. “But from the feedback that we get, the involvement that the Fed has in our corporate boardrooms has far surpassed I think the vision that any of us had in this room. I don’t believe you have the authority to make hiring and firing decisions, and that is feedback that we have had from members.”
Jordan Haedtler, campaign manager for Fed Up, said the Wells scandal offers a particularly instructive example of how boards of directors can be deceived or misled when they rely on management for technical information. The Fed needs to be extra careful in its efforts to retool what gets its attention, he said.
The Wells Fargo board was “too easily assuaged, and the board does bear responsibility for allowing those practices to continue,” Haedtler said. “The way that unfolded at Wells Fargo doesn’t make the case for allowing the board to be even more lax or … giving management more discretion in what they disclose or how they react when problems surface. This does seem to take things in the wrong direction.”
The proposal seems to have anticipated that concern, stating that boards are "still responsible for establishing policies that direct senior management how to manage the MRIAs and MRAs and when to escalate them to the board," thus keeping the boards themselves responsible for staying apprised of important supervisory matters.
Powell said the proposal actually aims to solve that problem by reducing the amount of the board’s time that is spent addressing MRAs. The 2013 guidance was intended to be overly cautious by directing all MRAs and MRIAs to both management and the board, but in practice it simply muddied the waters and made each party’s role less distinct.
“When everybody’s accountable for everything, nobody’s accountable for anything,” Powell said. “I think we contributed to a situation where we were conflating the roles of management and the board.”
Former Fed Gov. Daniel Tarullo, who headed the supervisory committee from 2009 until earlier this year when he retired from the central bank, said as much in a June 2014 speech. The directive of putting all MRAs on the board’s agenda probably hurt more than it helped, he said.
“We should probably be somewhat more selective in creating the regulatory checklist for board compliance and regular consideration,” Tarullo said. “There are some MRAs that clearly should come to the board’s attention, but the failure to discriminate among them is almost surely distracting from strategic and risk-related analyses and oversight by boards.”
Stanley said that this goal is laudable, and that there has been a tendency in recent years for rules to include board oversight without consideration as to whether that step was absolutely necessary. But the point of including the board in the first place was to give the risk management and compliance managers some recourse if they are sidelined by the more lucrative departments in the bank.
Using the London Whale as an example, Stanley said the board might not be to detect each errant trade, but giving compliance managers the ear of the board can ensure that they have leverage if they see activities that are unsound.
“Clearly, in the London Whale, there was a big priority put on making the most money off surplus deposits rather than managing risk properly,” Stanley said. “So it’s really about empowering one side of management that was demonstrably sidelined before the crisis.”
Baer said the point of the change is to help the bank board use its time more effectively, and presumably with more time the board will be better able to focus on the safety and soundness of the bank’s operations.
“It would be a substantive concern if, in the wake of the adoption of this proposal, all the banks cut in half the number of board of directors meetings,” Baer said. “But I don’t think that’s going to happen, and I think what you’ll see is a natural reallocation of time to more important issues.”