How Bank Boards Should Handle Regulatory Change

10-4-13-Manatt.pngBank directors should not think grimly about their service as a board member, even in the light of increased regulatory and shareholder pressure. While laws and regulations are constantly evolving, bank directors who approach their director work with clear focus, open lines of communication with management and a real understanding of the tenets of service as a director will be able to perform their functions at the highest levels that both regulators and shareholders have come to expect. Banks can, and must, build high performance boards that are ready to respond to the vast litany of responsibilities.

As a fundamental principal, the board must guide and set the overall strategic direction for a bank, and, in particular, establish the bank’s level of risk tolerance. How do high performance boards set that direction? They do that through approval of policies and procedures that set real standards for the scope and level of risk that a bank is willing to assume. Boards must ensure that this level of risk tolerance is communicated and adhered to at every level of the bank.

How can a board set this level of risk tolerance in responding to regulatory changes? Let’s take the Interagency Guidance on Sound Incentive Compensation Policies, which applies to all banks and thrifts. Incentive compensation benefits are used to attract key staff, induce better performance, promote employee retention and provide security to employees. In order to effectively analyze and ensure that incentive compensation arrangements at the board level take into account appropriate levels of risk, boards must clearly define an appropriate risk tolerance level which focuses on the long-term corporate health of an institution rather than quick, short-term gains. An incentive compensation policy should be structured around this framework.

How can you as a board member monitor management’s progress in both anticipating and responding to new regulations and assessing management’s ability to comply with new regulations? Ask questions in your board meetings and outside of your board meetings. Probe and challenge in a manner that is conducive to getting the information you need. Avail yourself of outside resources and advisors as appropriate.

Boards must also ensure that they have access to management and all employees at multiple levels. If boards are only getting information from their CEOs, they should be skeptical. Chief financial officers, chief credit officers, controllers and chief compliance officers, to name a few, all should all have the opportunity to present information to the board, and, as appropriate, be engaged in executive sessions where they can speak freely and openly about the supervisory and oversight process that management has provided.

In addition, boards must have independent sources of information separate and apart from management. In most board structures, for example, committees are devoted to overseeing various aspects of a bank’s overall operations. Audit committees can and should regularly interact with the bank’s independent auditors to make sure they are staying abreast of the latest developments. Similarly, compensation committees should leverage the work of outside counsel and advisors so that there is a complete understanding of significant changes in compensation rules and standards.

Finally, boards should consider charging committees with responsibility for overall risk management, whether at an executive committee level or with a specific risk management committee. Leveraging the work of committees can lessen the burden on any one particular director, as every director does not need to be an expert in every single field of exposure.

Building a high performance board today is not a luxury; it’s a requirement for success in an increasingly regulated and increasingly competitive environment.