It seems that all of the banking industry is abuzz about the prospects of potential legislative changes and financial regulatory reform. It is anticipated that Representative Jeb Hensarling will propose Financial Choice Act 2.0, bringing broad and sweeping changes to banking laws and a great number of regulatory changes. While most of the industry supports these changes, it is unclear if any of them will ultimately become law. With uncertainty about whether change in regulatory oversight will be made, we suggest that banks take a look at the functioning of their constant regulator: the board.
Most bank board members would recoil at the notion that they are regulators. They correctly view their role as enhancing shareholder value, which includes setting the strategy for the bank. In some cases, it is a dynamic strategy. However, the oversight function of the board requires that board members serve as the bank’s primary line of regulatory oversight. The board needs to ensure that the bank not only has reasonable programs in place designed to promote compliance with laws and regulations, but also that the bank is appropriately implementing the strategic plan adopted by the board. With that in mind, we believe bank boards can improve their oversight function by adopting some of the key proposals under discussion for regulatory reform.
- Adopt a limited number of key principles: A board’s primary guidance to management—the strategic plan—should set forth high level requirements for the direction of the bank. Developing a detailed operational plan at the board level, or attempting to co-manage the bank along with officers, is frequently counterproductive and causes management to spend too much of its time complying with the board’s requirements rather than building value in the business.
- Tailor oversight to the size and complexity of the institution: It is critical that the board’s oversight function evolve as the business model and the growth of the bank does. While we sometimes see boards impose requirements on management that are overly complex and burdensome, it is more common that boards fail to evolve their oversight as the bank grows and becomes more complex. This issue is particularly prevalent among fast-growing, acquisitive banks. Boards sometimes take the same approach to compliance and regulatory oversight as they did when the bank operated in a single community with a small number of conventional products.
- Eliminate concentrations of power: Just as many bankers find the unchecked power and single director structure of the Consumer Financial Protection Bureau objectionable, concentrating too much power in one or two directors can also be destructive for a bank. Among the bank failures we saw, a disproportionate number relied on the oversight and guidance of a single dominant director. A properly functioning board should foster discussion and debate among directors with diverse business backgrounds, risk tolerances, and points of view. Moreover, directors should feel accountable to each other and to shareholders.
- Eliminate useless reporting: Just as bankers seek to streamline regulatory reporting, board reports should be streamlined as well. When was the last time your board had a discussion about the usefulness of the various reports received at each board meeting? There is a terrible opportunity cost to having some of the best minds in the bank prepare reports that do not provide actionable information or, even worse, are ignored by board members. Boards should periodically discuss which reports are no longer helpful, and also, which types of additional reports might be beneficial as the business model of the bank evolves.
- Provide timely feedback: One of the less publicized provisions of the Financial Choice Act is a requirement for timely delivery of regulatory exams. Boards should adopt this policy as well with regard to key board actions and feedback to senior management. A concern raised in a board or committee meeting without timely resolution by the board can leave management in limbo, afraid to make any decision that might ultimately be deemed by the board to be a bad one. If the board’s oversight function raises a concern, boards should work to resolve the concern and take any necessary action as quickly as possible in order to allow management to move forward.
In a deregulatory environment, it may seem strange that attorneys would suggest that boards likewise streamline their oversight function. However, it is our belief that reducing regulation is not nearly as important as improving the effectiveness and efficiency of regulation. By focusing the board’s oversight function on monitoring the key risks of the bank in an efficient manner, board members will create more time to focus on developing effective strategy, and for their management teams to focus on building value for the bank. Thoughtful board oversight is as important as regulatory relief for the industry, if not more so.