In Banking, Judgment Counts

Does an experienced banker necessarily make for a good bank director? Citigroup and Bank of America Corp. are about to find out, having bowed to pressure from federal banking regulators to recruit veteran bankers and finance experts to serve as independent directors on their beleaguered boards.

Unless you’ve been marooned on Mars without your Blackberry for the last 18 months, you surely know that Citi and Bank of America have been tossed around like flotsam on the angry seas of global finance.

Citi reported an $18.7 billion loss in 2008-the direct result of an astonishing $19.2 billion in credit writeoffs. Bank of America somehow managed to squeeze out a $4 billion profit last year compared to $15 billion in 2007, but it still racked up an only slightly less astonishing $16 billion in credit losses in 2008. Each bank has received a total of $45 billion in two separate tranches from the U.S. Treasury Department’s Capital Assistance Program, along with generous loss-sharing arrangements.

When you consider the troubling events of the past year and a half-including the very real possibility that Citi, or Bank of America, or both, would have failed without help from Uncle Sam-it was inevitable that their respective boards of directors would come in for some harsh scrutiny. In March, Citigroup announced the selection on four new outside directors: former U.S. Bancorp CEO Jerry Grundhofer; one-time Bank of Hawaii Corp. CEO Michael O’Neill; William Thompson, who previously had been co-head of bond investor Pacific Investment Management Co.; and Anthony Santomero, formerly president of the Federal Reserve Bank of Philadelphia.

And in May, after a much-publicized stress test of large U.S. banks concluded that it needed to raise nearly $34 billion in fresh equity capital to protect against possible future losses, Bank of America announced that it had selected four new independent directors: ex-Federal Reserve Board Governor Susan Bies, who also spent several years at First Tennessee National Corp. where she oversaw the bank’s risk management function; former Banc One Corp. Executive Vice President William Boardman, who quarterbacked that bank’s expansion strategy in the 1980s; former Compass Bancshares CEO Paul Jones; and former FDIC Chairman Don Powell, who was also once a banker.

I spoke to one regulatory lawyer with knowledge of the situation who says the Federal Deposit Insurance Corp. was an especially strong proponent of the board changes at Citi and Bank of America, although the Comptroller of the Currency and Federal Reserve would have had to concur in that decision. Given the magnitude of loan writeoffs at Citi and Bank of America last year, coupled with a decision by both banks in recent months to replace their chief risk officers, the feds apparently saw a need for better risk management oversight at the board level. “What you want is an experienced and opinionated board that will enhance the overall risk management capability of the company,” says equities analyst Anthony Polini, who covers Bank of America for Raymond James. “I think that’s why the regulators recommended changes at the board level.”

In recent years I’ve had the opportunity to meet or interview Grundhofer, Bies, Boardman, and Powell. They are quality people with a lifetime of experience in this business. But I return to my original question: Does a banker necessarily make for a good director?

Make no mistake, having knowledge of banking, the capital markets, and risk management will be helpful. But it is no substitute for good judgment and the willingness to push back when you don’t agree with management’s position on something of material interest to shareholders. Risk management is a complex and highly technical activity at the management level. At the board level, however, it must by necessity assume a broader perspective: How much risk is the bank willing to take on, and what kind of credit culture does the board want it to have? Considering the magnitude of losses at Citi and Bank of America, it would seem that both companies went too far out on the risk curve, with their boards’ acquiescence.

To me, good governance hinges on two things: honest communication between management and the board so that everyone knows everything they need to know, and having directors who aren’t afraid to exercise their authority. These eight new directors may be smart people who know a lot about banking and finance, but it’s just as important that they also bring sound judgment and an independent character to the Citi and Bank of America boards. They have not been brought in to manage risk, their backgrounds notwithstanding. They are there to set the appropriate tone at the top, and enforce it.

Being a banker might make you a better bank director, but not necessarily. Judging by the mess at Citi and Bank of America, it seems obvious that being a banker doesn’t necessarily mean you know how to run a bank.