Big Changes Loom for Bank Boards

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Directors and top management at banking organizations should consider carefully the significant changes in bank regulatory expectations for board members. These expectations are rigorous, and there should be no doubt that the bar has been raised. This trend will continue in the years to come.

These expectations come up in a variety of areas, from new risk management and governance requirements of Dodd-Frank, to revisions to the Basel international capital framework, to supervisors raising the bar on innumerable bank processes.

Some will say that these expectations are too tough. Even in good times, the list of "must-dos" let alone "should-dos" for board members is long, particularly the work of the audit committee and risk committees, in addition to the performance of the board itself. Readings can be voluminous; meetings are longer and more intense.

The do's and don'ts of board governance are still emerging, and there is an honest debate over the core topics — how effective new and detailed expectations are at improving safety and soundness, and whether new standards are merging the concepts of governance and management. However, the fact of the matter is that regulators are not going to back away from their enhanced expectations for the board. Board members and managers who do not take heed proceed at their peril.  

Set out below are a few items that should be followed with care:

  1. Board members are expected not just to be diligent readers, but to effectively challenge management and help set the strategic and risk agenda for the company. A passive board is likely to draw regulatory criticism. Board members must hold management accountable and exercise independent judgment.
  2. Board discussions should be documented, as should other evidence of active governance. Little or no discussion and debate around serious bank matters will be viewed by regulators as insufficient. The old form of board minutes that merely list actions taken is no longer satisfactory. And regulators will look at more than just minutes in assessing the performance of a board.
  3. Board materials should be sufficiently robust, and boards should have enough time to digest and discuss materials, particularly in respect to major decisions. Common sense is important here. Reams of material, distributed days before a meeting in large and complex "decks," where management takes only scant time to explain the issues set out, will invite regulatory criticism. Indeed, regulatory scrutiny of lax practices, which already forms much of the basis for liability litigation against directors, will become increasingly intense.
  4. All board members should have a genuine understanding of the bank's businesses and the associated risks, including any compliance or consumer protection obligations. Obligations for risk, compliance and audit committee members are much greater in this regard.
  5. Where banks are engaged in major transactions, major new businesses, major decisions about risk appetite or other matters of unusual importance, board involvement, including time to consider and debate, is especially important. It behooves boards to demonstrate that they genuinely understand the particular issue before them and have considered carefully the risks presented by the matter.
  6. Boards should, in fact, be able to demonstrate that they are acting for the best interests of their firm with all relevant risks taken into account. Directors have to recognize and avoid any real or perceived conflicts of interest.
  7. Banking agencies now have more detailed expectations for risk management and governance—including the role of board risk committees—that should be reviewed and followed with care. Establishing and maintaining open and regular communications with the supervisory agencies is important to assist the board and management to properly interpret these expectations and apply them to normal duties and responsibilities.
  8. Successful boards will go beyond the letter of the requirements and take steps to focus on whether the culture of their banking company supports its stated governance and risk management processes, and visibly models the desired practices.
  9. Managements will avoid painful regulatory challenges if they assist their boards and go out of their way to follow the spirit as well as the letter of the emerging regulatory expectations.

These are only a few of the important aspects of board governance where increased regulatory oversight is changing or enhancing board practice. I predict there will be more to come.
Eugene A. Ludwig is a founder and the chief executive of Promontory Financial Group LLC. He was the comptroller of the currency in the Clinton administration.

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Law and regulation