The Dodd-Frank Wall Street Reform and Consumer Act has been in effect for nearly four years, and almost 75 percent of the required regulations have been written or proposed. Issued regulations help to clarify requirements, but the climate created by expectations of regulators continues to create additional challenges for boards.
Boards must first understand these regulatory expectations and then balance them against shareholder interests at a time when it is increasingly difficult to meet earnings expectations. As a result, financial institution directors are asking, “What should I know?” and “What may be coming next?” While it is impossible to know exactly what may be next, there are themes that are emerging from the current environment to which directors should pay particular attention.
This will continue to evolve for the larger banks. Models for credit are changing to take into account improving credit statistics. Models for pre-provision net revenue and operational losses continue to be refined. Smaller banks without stress testing should be developing their testing. Banks with more than $10 billion in assets are required to stress test, so boards must ensure that their models continue to be challenged and validated. Simultaneously, similar testing for liquidity is being developed, and the regulatory pressure to understand liquidity positions and make progress toward achieving required liquidity ratios will be significant. The board should understand where the bank’s testing stands along the developmental curve and be prepared to challenge findings and address changing needs.
Compensation and Human Resource Practices
Dodd-Frank requires financial institutions to review incentive plans and eliminate rewards for risky activities. At the same time, the so-called horizontal review of pay practices at the largest financial institutions are creating regulatory expectations and standards that may not be as apparent, but will require more board involvement in pay decisions and structures. There is no area that will be more difficult to get right, as many of the regulatory requirements are inconsistent with the expectations and demands of shareholders. Risk and compensation committees will need to interact more as it relates to pay practices. The board should be prepared to challenge reporting structures that could increase risk or negatively impact controls in the financial institution.
Mortgage Lending Requirements and CRA Performance
It remains to be seen how the new ability-to- repay and qualified mortgage rules may impact a bank’s Community Reinvestment Act (CRA) performance. Directors will need to keep a close eye on CRA performance at their institutions, as it may be more difficult to generate loans in the more underserved communities.
Third Party Providers
Guidance issued by the Federal Reserve in December on managing outsourcing risk made clear that responsibility for the activities of third party providers remains with the financial institution. The board also must ensure that clear policies for managing these relationships are in place and followed. Less obvious are newly issued proposed rules related to diversity. These rules require boards to ensure that there are policies and practices in place to promote diversity in the supplier base as well as the financial institution’s workforce.
New Products and Services
As the earnings environment faces declining revenue streams (like mortgage) and increased compliance expenses, financial institutions will search for new ways to grow revenues. Boards will need to pay close attention to strategic plans and include risk reviews of strategies (including new products and services) to ensure that they align with their institution’s risk appetite.
Any of these topics could be the subject of its own article on the role of the board and its committees, and there are endless other issues that could (and must) be considered. It is clear that the responsibility and time commitment of boards of financial institutions will continue to expand and evolve at a rapid pace for the near future. Keeping abreast of regulatory interpretations and expectations has never been more important to the success of a financial institution and its board.