The fourth part of the Evolving Banking Regulation series for 2015 examines the governance challenges facing banks. In the latest edition, we focus on how to meet the expectations of regulators and supervisors while addressing the commercial advantages of good governance. Elements such as culture, values, supervisory assessment and the suitability and accountability of board members and senior management are also reviewed.
Analysis of the financial crisis revealed poor quality decision-making and poor quality oversight of risk by many bank Boards. The governance of many banks was at best fractured, at worst broken. Facing commercial, shareholder and regulatory pressures to improve their governance, most banks recognize the commercial advantages of good governance including:
Meanwhile, standard setters have begun to define what good governance looks like, with a particular focus on the role of the Board and on risk governance. For example, international standard-setters and national authorities have strengthened their rules and guidance on governance; and supervisors have increased the intensity and widened the scope of their interactions with banks Boards and senior management. The process for changing board governance began with remuneration, reflecting the initial post-financial focus of the G20 and national politicians. Regulatory and supervisory attention was then extended to improving the functioning of some long-standing areas of governance where banks had less focus ahead of the financial crisis. These include the separation of the roles of the Chair of the Board and the CEO; the knowledge, experience, expertise, independence and time commitment of the non-executive directors, and the extent of the challenge they provide; and various specific aspects of risk governance.
Most recently, the focus has widened to the role of Boards in establishing, communicating and assessing the culture, value and behaviors of the bank; the assessment (by banks and their supervisors) of the suitability of Board members and senior management; and holding senior management personally accountable for their bank meeting regulatory requirements and expectations.
The regulatory consequences of poor governance in banks have become clearer. Supervisors have become increasingly active and tougher in directing banks to improve their governance; in assessing the suitability of new senior managers and Board members; in making more use of Pillar 2 capital add-ons in response to poor governance and controls; and in taking disciplinary action – against banks and where possible against individuals – when serious problems emerge. There is less solid evidence of investor pressure being brought to bear on banks.
Banks have improved their governance, in part in response to these commercial, regulatory and supervisory pressures. At Board level, we observe more attention being focused on understanding risk, on setting risk appetite, and on controlling, measuring, monitoring and reporting risk. This includes a reinforcement of the Board with non-executive directors who bring a deeper experience and expertise of banking and risk management; a more active role for the Board Risk Committee; a closer consideration of risk maps and risk related management information; and establishing and elevating the role of the CRO in discussing risk with the Board Risk Committee and/or the Board itself. However, further progress in some key areas of governance is needed:
To make further progress, banks may find it useful to:
The report goes to examine in greater detail, the areas where greater progress is needed in Board governance for banks. This includes addressing the challenges of putting a greater emphasis on risk at the board level, how to reinforce the three lines of defense in risk management, enhancing the overall risk management function, introducing risk related remuneration and how to affect data and IT governance.
Additional opportunities to improve governance and risk management are examined in board composition and roles, control functions, clarification of responsibilities, remuneration and how to measure overall board effectiveness.
Finally, the report concludes with an assessment of international standard setting including Basel committee corporate governance principles, EBA SREP guidelines, FSB standards on governance, CRD4 standards on governance and FSB commentary on remuneration. In conclusion, the report examines how international standards are being applied at the national level including a number of elements of regulation and supervision.
Providing an overview of these numerous aspects of the shift in governance thinking and process in the current regulatory environment, EBR4 is a helpful map on the many trends and influences that boards and board members must recognize and engage with to be successful in today’s challenging regulatory environment for banking.