New Guidelines make this the perfect time for banks to renew their focus on internal governance.
The arrival of new EBA Guidelines on internal governance will only reinforce supervisors' growing focus on this wide-ranging topic. Banks should ensure that they understand where supervisors see the greatest `expectation gaps', that they are prioritising their responses effectively, and that they are taking the right steps to achieve lasting improvements in internal governance.
We often discuss internal governance in our quarterly ECB newsletter, but rarely as a topic in its own right. After all, most banks view strong internal governance as a permanent priority, not a one-off target. It is also a very broad topic, incorporating themes as varied as management bodies, control frameworks, risk management and organisational culture.
Nonetheless, internal governance remains a key area of focus for European banking supervisors. That is hardly a surprise, given the fundamental role it plays in maintaining the stability and reliability of individual institutions and - by extension - the entire banking system.
Furthermore, 30th June 2018 sees the entry into force of new EBA Guidelines on internal governance - the most comprehensive guidance on the topic since 2011.
In our view, the introduction of the new guidelines will only highlight the difference between supervisory expectations for banks' internal governance and the reality `on the ground'. The size of this gap is illustrated by the latest SREP results, which appear to show that no SSM banks have achieved the optimal score of 1 in the area of Governance and Risk Management. Danièle Nouy's speech of April 2018, “Risk appetite frameworks: good progress but still room for improvement”, also makes it clear that supervisors urgently want the expectation gap to close.
The ECB's Annual Report for 2017 gives a more detailed insight into the areas that banks should prioritise. It shows that many on-site inspections made severe findings in areas such as organisational structure, the role and responsibility of management bodies, internal audit and the compliance function. To take two examples in greater detail:
Against this background, the arrival of the EBA's new Guidelines means that now is the perfect time for banks to renew their efforts to address internal governance weaknesses.
But that begs a number of questions. How can boards best take ownership of such a large and complex set of challenges? After all, some feel it is impractical to objectively judge an evolving, risk-sensitive target like internal governance against a rigid set of standards.
It also remains to be seen how supervisors will implement the new rules. How much flexibility will they apply? Will they allow banks to harness new technology to the goal of improving internal governance?
In our view, effective prioritisation is essential to `working smarter' and closing as many expectations gaps as possible. We believe banks should focus on:
Looking further ahead, we also see a number of areas that banks should prioritise in order to `future proof' the quality of their internal governance. In particular:
In conclusion, internal governance may not be a new topic, but it is only climbing higher on supervisors' lists of priorities. With attention on deficiencies growing, banks need to ensure they are prioritising the right actions, eliminating the most serious expectation gaps and building a sustainable framework for effective governance.