Have you ever wondered what a board of directors actually does?
Watching a group of directors at work isn’t as exciting as, say, well…just about anything else you could think of. Have you ever watched a televised meeting of your city or county commission on the local public access channel? It’s not even as interesting as that because at least with those meetings – and here I am reaching w-a-y b-a-c-k into my memory of having covered (too) many of those as a fledgling staff writer for a small daily newspaper in Martins Ferry, Ohio – you never know when a gadfly will show up and want to speak.
And yet the work of the board is critical, and strong boards make a tremendous contribution to the success of their organizations. This is true in banking as in any other industry, and also in the nonprofit sector. Governance is a deliberative process in which a group of individuals talk, debate (sometimes argue) and make decisions that help guide the organization in its pursuit of certain goals. It might not make for compelling reality TV, but strong boards do many things that make a material difference.
In my last post I offered five of 10 best practices that I have seen in high performing boards, which were taken from a presentation that I made earlier this month to approximately 200 bank directors and CEOs at the CEO & Board University in Westborough, Massachusetts. Here are the remaining five.
Best practice #6 is to demonstrate an ongoing commitment to learning and education.
Most outside directors serving on a bank board face the challenge of learning a complicated industry on the fly because there’s usually no apprentice program. The mechanics of good governance are actually pretty straightforward and a smart person can pick them up pretty quickly. But banking is a complex business, in part because of regulation, but also because the economics are different than in most other industries. Ultimately, a director’s effectiveness will depend on how much they know about the business of banking. It is not the role of the board to run the company. But how can the board exercise its fiduciary duties to shareholders, or be a valuable resource to management, if its members don’t understand the businesses that the bank is in, or the regulatory issues that it faces?
Learning and education can be structured a couple of different ways. You can attend conferences, including those offered by Bank Director. Some banks will have an outside advisor, or member of senior management, make a short presentation on some important topic at every board meeting. I don’t think that substitutes for a deeper learning experience, but it can be helpful. And it’s important that individual directors commit to studying on their own. It would be great if there was someone in the bank who understood the industry – including all of the critical issues — well enough that they could push out a monthly reading list.
This is asking a lot because most directors are very busy, but a board level commitment to ongoing education is important. Basic intelligence, life experience and sound judgment are important qualities for a director, but they can only take you so far. You need to know enough about the business of banking to have a meaningful dialogue with management, ask the questions that need to be asked and fulfill your fiduciary duties.
Best practice #7 is to understand your bank’s strategy and levers of profitability.
Strategy becomes very important in a tough business climate where the economy is working against you rather than for you. Strategy wasn’t as important in 2004, when the U.S. economy was booming and a strong housing market was leading the way, as it is today. Industries with excess capacity often see their products turned into commodities, which ultimately impacts their profitability. I think the only way out of the commodity pricing trap is through a strategy of differentiation where you create a unique value proposition that the customer is willing to pay more for. It is not the board’s job to set the strategy of the bank. That’s management’s job. But the board needs to understand it and have meaningful discussions with the management team when the bank’s strategic plan is being formalized and participate in that process. The board also needs to understand how the bank makes money and where those pockets of profitability are located within the organization.
Best practice #8 is to have a fundamental understanding of risk management.
One of the board’s most important roles is to build value when times are good and preserve value when times are bad. Risk management is how you preserve value during hard times. It has been a growing trend in recent years to establish a board level risk committee – and at larger banks, to hire a chief risk officer. The full board can delegate some of the governance responsibility for risk management to a risk committee – but it is still important that all directors be conversant with the concepts and principles of enterprise risk management. This is an area that the regulators have been focusing on more since the financial crisis – and they expect bank directors to understand it.
Two hundred and ninety-seven banks failed in 2009 and 2010 as a direct consequence of the financial crisis. I would willing to bet that a majority of those failures stemmed from decisions board and management made together that violated some principle of good risk management – probably credit risk, and most likely concentration risk along with it.
Best practice #9 is to understand the regulatory environment that your bank operates in and promote a strong compliance culture.
It’s certainly no secret that the regulatory environment has become much tougher since the crisis. The federal prudential regulators – the Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and Federal Reserve – as well as the Consumer Financial Protection Bureau can make a bank’s life very difficult if they choose to, so compliance has to be a top priority for the board.
Every board member should know what principal laws bank regulators are focused on – the Bank Secrecy Act and anti-money laundering requirements have been a big one of late — and whether or not the bank is in compliance with those. The board should also have a good feel for the recent trends in enforcement actions. There are occasions when the board or individual directors will have face-to-face contact with the bank’s primary regulator, as when they present the results of an examination. But even though most of the contact with the regulators will probably occur at the management level, the board is still responsible for setting the tone for regulatory compliance throughout the bank
Best practice #10 is to be aware of the world around you and how that is affecting your bank.
There are great changes taking place in the banking industry today, including the impact of mobile technology on the distribution of many bank products, the entry of large technology companies like Google and Apple into the payments sector and the historic demographic shift that is beginning to reshape the industry’s customer base as millennials become a much larger force in the U.S. economy.
Every bank — even a behemoth like JPMorgan Chase & Co. — is impacted by external events and trends. Much of the board’s work is inwardly focused – quarterly earnings, an announced acquisition, management or board succession issues, the annual shareholders meeting, year-end financials. But I think it’s important for directors to pay attention to how the industry is changing. This is actually something that the board is better equipped to do than management, which tends to be even more internally focused than most directors. Don’t allow yourselves to become too myopic.
Until next time, Ciao.