A bank’s board of directors must answer to a variety of constituencies, including shareholders, regulatory agencies, customers and employees. At times those constituencies may have competing interests or priorities. Other times, what may appear to be competing interests are actually variations of aligned interests.
One area where this is particularly true is the board’s responsibility to strike the right balance between driving revenues and ensuring the bank adheres to its risk appetite established as part of its enterprise risk management framework.
The failure to strike this proper balance can be devastating to the institution, and if widespread, could result in consequences across the entire industry, such as the 2008 financial crisis. As technology and innovation accelerate the pace of change in the banking industry, that balance will become more critical and difficult to manage. And as banks explore ways to increase profits and remain competitive, especially with respect to noninterest income, bank directors will need to remain diligent in their oversight of new bank activities.
Regulators have offered guidance to bank boards on the subject. For example, the Office of the Comptroller of the Currency (OCC) issued a bulletin in 2017 that defines “new activities” to include new, modified, and/or expanded products and services and provide guidance related to risk management systems for new activities. While it is management’s role to execute strategy and operate within the established risk appetite on a day-to-day basis, the board’s role is to oversee and evaluate management’s actions, and the board should understand the impact and risks associated with any new activities of the bank.
To exercise this responsibility, directors should challenge plans for new activities by posing the following questions to help them determine if the proper risk approach has been taken. Questions may include:
- Does the activity align with the bank’s strategic objectives?
- Was a thorough review of the activity conducted? If so what were the results of that review and, specifically, what new or increased risks are associated with the activity, the controls, and the residual risk the bank will be assuming?
- Is the associated residual risk acceptable given the bank’s established risk appetite?
- Is the bank’s infrastructure sufficient to support the new activity?
- Are the right people in place for the activity to be successful (both the number of people required and any specific expertise)?
- Are there any new or special incentives being offered for employees? If so, are they encouraging the correct behavior and, just as importantly, discouraging the wrong behavior?
- What are the specific controls in place to address any risks created?
- How will success be measured? What reporting mechanism is in place to track success?
- Will there be any impact on current customers? Or in the case of consumers, will there be any disparate impact or unfair or deceptive acts or practices (UDAAP) implications?
- What third parties are required for successful implementation?
- What limits on the amount of new business (concentration limits) should be established?
- Are the applicable regulators aware of the bank’s plans, and what is their position/guidance?
These threshold questions will assist directors in becoming fully informed about the proposed new activities, and the answers should encourage follow up questions and discussions. For example, if third parties are necessary, then the focus would shift to the bank’s vendor management policies and procedures. Discussions around these questions should be properly documented in the meeting minutes to evidence the debate and decision-making that should be necessary steps in approving any new bank activity.
If these questions had been posed by every bank board contemplating the subprime lending business as a new activity, it may have averted the challenges faced by individual banks during the financial crisis and lessened the impact on the entire industry.
In the future, if boards seek the answers to these questions, the following discussions will help ensure directors will give thoughtful consideration to new activities while properly balancing the interests of all of their constituencies.