In the morass of regulatory burden imposed on banks following the crisis, one area where the pendulum swung way too far was in regulators’ approach to banks’ boards of directors. Thankfully, policymakers appear willing to bring the pendulum back.

Federal Reserve Board Gov. Jerome Powell recently told CNBC that the central bank is “working on a reset … of how our supervision interacts with boards of directors.” He said the aim is to move toward a “more principles-based approach” to focus boards on holding management accountable, with fewer mandates and checklists. Similarly, the Treasury Department’s June report on “core principles” for regulation calls for reassessing regulatory requirements on bank boards.

That same Treasury report calls out “the failure of board governance and oversight of banking organizations” as a major contributor to the banking crisis. There is no question that poor board governance and oversight contributed to the financial crisis.

But there are few, if any, constituencies I can think of that did not contribute to the crisis. That list includes bank management, nonbanks and the capital markets, regulators, politicians and even consumers.

Poor board governance and oversight were not the root cause of the crisis. Boards were unable in many cases to catch and correct overly risky behavior by senior executives before it was too late. But directors’ failures were derivative failures of bank management in the areas of business, risk and control. Key managers were clearly not up to the task and did not provide the information and candor needed to adequately enable and compel effective governance.

An unfortunate result was that regulators, overlooking root causes, became increasingly harsh in their communications with directors, while their expectations of board responsibilities became overly burdensome and prescriptive.

I have witnessed firsthand the escalation of regulators’ requirements for, and criticism of, bank boards. Supervisory policies and communications are riddled with “the board must,” “the board failed” or both. While in some cases one or both statements are appropriate, those not-so-subtle statements have in other cases become regulatory crutches that carry unintended consequences, downplay the accountability of management, blur the roles between management and directors, and obfuscate directors’ oversight and governance responsibilities. This serves to diminish the credibility of regulators both in Washington and the field.

Clearly there is a need for regulators to rethink their expectations and requirements for boards as the pendulum has swung way too far. But in doing so, regulators also need to maintain certain principles of sound board governance and oversight to guard against an overcorrection. A principles-based approach that seeks to position boards as watchtowers for their banks while not subjecting directors to overly burdensome restrictions is a worthy goal.

As regulators recalibrate policy on interactions with boards, they should consider the following:

Director qualifications

The Enhanced Prudential Standards required by the Dodd-Frank Act that at least one member of a bank’s risk committee have experience in identifying, assessing and managing risk exposures of large, complex firms. Regulators should consider applying similar expectations more broadly to a bank’s board of directors.

Bank boards are often overpopulated with successful business builders and influencers from other industries. But they may well benefit from a better balance between members that enable business and those with expertise in contemporary banking, bank operations, risk management and control. Directorates with balanced expertise should be better positioned to critically evaluate strategic and tactical business plans, business performance and risks, and the sufficiency and operation of risk and control frameworks.

Boards should be able to exercise the healthy skepticism and “credible challenge” required to effectively govern and oversee management, understand the realities of being regulated. Boards that lack balance and perspective will be overly dependent on bank management and where management fails, so too will boards.

Engagement and communication

Regulators should strive for more frequent board engagement and clearer, more candid, communications throughout the supervisory process. Too often regulators only spend “quality” time with boards when there are problems, and too often boards are surprised by seemingly sudden and extreme swings in regulators’ tone. Regulators and directors need to build relationships so that they may share healthy dialogue, perspective and candor.

When candor is needed about management or subjects that management may not be viewing as objectively as they should, regulators should request executive sessions with boards. In addition, regulators should engage board members and share perspectives and concerns in both good and bad times.

Independence

Sound board oversight and governance require directors to maintain independence from management in terms of their attitude, thinking and action. This principle is not always reflected in published regulatory standards.

Too often it seems that directors are “captured” by or associated with, or at the other extreme completely ignorant of, the attitudes of executives. Boards are no doubt key instruments in setting and communicating organizational attitudes and establishing how a bank’s leaders set a “tone at the top.” As such, they need to be particularly attuned management to attitudes in order to champion them where appropriate and act as independent change agents when they are inappropriate.

For example, organizational attitudes toward consumer complaints vary widely across the industry. Some view them as compliance nuisances and afford them minimal remediation effort, while others will carefully analyze what complaints may be saying about the organization with an eye toward assessing and managing risk, bettering offerings or operations, and improving the customer/consumer experience.

Similarly, attitudes toward risk managers and auditors run from costly business nuisances to necessary independent checks and balances on business risks and behaviors. Boards and board members need to be choosy about the organizational attitudes they adopt and espouse. Those who cannot sufficiently separate themselves from, and act as independent change agents for, counterproductive and/or undesirable organizational attitudes cannot effectively govern. Regulators need to keenly focus on the importance of independence in enabling directors to serve as a “credible challenge” to management.

David Gibbons

David Gibbons

David Gibbons is a senior adviser with Alvarez & Marsal Financial Industry Advisory Services in Chicago. He formerly held several senior-level positions at the Office of the Comptroller of the Currency.

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