Part 3: Best Practices for Bank Boards


team-row.jpgOver the past several years we have seen the regulatory agencies become much more focused on board oversight and performance.  This is a natural point of focus for regulators in a time of crisis in the banking industry.  The fiduciary and oversight obligations of members of boards of directors are well established, and there is a road map in the corporate records for following the actions and deliberations of a board.  I would suggest, however, that a board could receive a gold star for the quality of its minutes and its adherence to the established principles of corporate governance, and yet fall well short of being an effective working group.

This is the third in a series of articles of best practices for bank boards.  Over the past several decades my partners and I have worked with hundreds of bank boards.  Regardless of the size of the entity we have noticed a number of common characteristics and practices of the most effective boards of directors.  In this article, I will discuss three additional best practices—meeting in executive session, making use of a nominating committee and director assessments and participating in the examination process.

Best Practice No. 6 – Meet in Executive Session

It is not uncommon for the most passionate and meaningful discussions among board members to occur in the parking lot of the bank following a board meeting.  Much more time is spent in these parking lot sessions discussing a possible sale of the bank and the compensation and performance of the bank CEO than ever takes place in the board room.  The most effective boards of directors move these conversations to the board room by means of executive sessions.  Whether monthly or quarterly, the independent (i.e., non-management) directors meet in executive session and set their own agenda for those meetings.

I have found that CEOs who welcome and facilitate such executive sessions never regret doing so.  Executive sessions provide a structured forum for the independent directors to meet as a group and speak freely regarding matters of interest and concern to them.  Many positive ideas and discussions can result from these sessions.  If the CEO is also chairman of the board, a “lead director” can chair the executive sessions.  A best practice is for the chairman or lead director to meet with the CEO following an executive session and report on the substance of the matters discussed.

Best Practice No. 7 – Make Use of a Nominating Committee and Director Assessments

No director has a “right” to sit on a board.  Members of the most effective boards of directors have an active desire to serve the bank, which is evidenced by a high level of engagement, preparation and participation.  There should be a transition from the typical practice of automatically re-nominating existing board members to a process of conducting annual director assessments coupled with a nominating committee for director elections.

The CEO should not be involved with either director assessments or the nominating committee—these are board functions and should be managed by the board under the direction of the chairman or the lead director.  Annual director assessments could initially be done by means of self-assessments, coupled with a one-on-one meeting between each director and the chairman.  These one-on-one meetings can serve as the basis for discussion of the director’s enthusiasm for and participation in the activities of the board.

The process of implementing an active nominating committee and annual director evaluation process is also about risk management going forward.  In these times of continued economic uncertainty and increased regulatory scrutiny, it is important that banks have active and engaged directors.

Best Practice No. 8 – Actively Participate in the Examination Process

Members of the board should be involved in the regulatory examination process.  The regulators really do want and expect the board to be involved in and understand the issues which the regulators believe may be facing the bank.  Involvement of the entire board or key members of the board from the first management meeting with the examiners to the exit meeting is tangible evidence that the board is actively engaged in oversight of the bank.  It can also be beneficial for members of the board to hear the concerns of the regulators directly, and to observe management’s interaction with the examiners.

I recently attended an exit meeting with bank management following conclusion of an exam.  Several of the bank’s directors were present because they wanted to get a preview of the exam findings on asset quality.  During the exit meeting the lead examiner raised concern about a risk management issue of potentially significant magnitude.  The issue clearly took the bank’s CEO by surprise, but the presence at the meeting of the board’s chairman had a calming effect.  The chairman looked across the table at the lead examiner and said in a convincing tone, “We will fix this immediately.”  The issue was then quickly resolved, and the final examination report commented favorably on that action.  The end result may well have been the same without the presence of board members at the exit meeting, but I believe their presence was very helpful and reflected well on the bank.

Part 2: Best Practices for Bank Boards


megaphone-full.jpgOver the past several years I have attended dozens of meetings of boards of directors of banks in troubled condition.  The vast majority of these boards were well functioning and had dedicated and hard working directors.  Geographic location has been the predominant factor in determining winners and losers among banks in this challenging economy.  However, there have been several situations in which it appeared to me that the composition of a board, and the interpersonal dynamics among its members, had magnified the impact of the economic downturn.  A bank board is like any other working group in that the direction and decisions of a board can be heavily influenced by members who dominate the conversation, or by members who actively discourage discussion or dissent.

This is the second in a series of articles on best practices for bank boards.  During the past several decades, my partners and I have worked with hundreds of bank boards, for institutions ranging in size from under $100 million in assets to well over $10 billion in assets.  Regardless of the size of the entity, we have noticed a number of common characteristics and practices of the most effective boards of directors.  This series of articles describes ten of those best practices.  In the first article in the series, I focused on two fundamental best practices—selecting good board members and adopting a meaningful agenda for the board meetings.  In this article I will discuss three additional best practices—providing the board with meaningful information, encouraging board member participation and making the committees work.

Best Practice No. 3 – Provide the Board with Information, Not Data

Change the monthly financial report to something meaningful.  Most boards need to know only about 20 to 30 key data points and ratios and how those numbers compare to budget, peer banks and prior year results to have a good handle on the condition of the bank.  By contrast, the typical financial report at a bank board meeting is encompassed in a 25 to 30 page document that blurs into a very detailed, and often meaningless, recitation of data that is difficult to follow.

Providing meaningful information in an understandable format is essential for the board members to identify and manage risk.  Less is often more in effective board presentations. 

Best Practice No. 4 – Encourage Board Participation

No board should be burdened with a devil’s advocate who has to speak in opposition to everything, but there should be an atmosphere in the board room which allows for dissenting views and occasional no votes.  Far too many meaningful questions go unasked in the board room.  Board members need to feel empowered to ask challenging questions, and also to say that they don’t understand a proposal or a presentation.

In my experience, a very powerful question is the question: Why?  A sense of momentum and inevitability can develop during the discussion of a proposal in a board room, particularly when the discussion is dominated by one or more directors who are persuasive or who feel strongly about a position. 

I know several bank boards that greatly benefitted from a few independent thinking directors in the years running up to the current economic downturn.  Those directors had the insight and the courage to question generally held beliefs in a boom real estate market.  More importantly, the culture of the boards on which they served allowed for real discussion of concerns expressed by directors.

Best Practice No. 5 – Make the Committees Work

The best functioning bank boards almost always have an active and involved committee system.  There is effective leadership of their committees, and the committee members take the time to read and analyze management reports and related materials in advance of meetings.  If you ever need to provide motivation for committee members to be more focused and attentive, give them a copy of one of the complaints filed in litigation by the FDIC against directors of a failed institution.  Almost all of the FDIC lawsuits assert a lack of adequate attention and focus by directors, and particularly by loan committees.

Directors should not become micro-managers, but management of the bank should feel that board members are holding them to a certain level of performance and accountability.  “Noses in and fingers out” is a good maxim for directors to follow, whether in the committee setting or on the board as a whole.

A strong committee system also helps build real expertise on the board, which can help support management.  Future board leaders can be identified through their work on committees.  We recommend that committee chair positions, particularly among the two or three most active committees of the board, be rotated every few years.  This allows for broader exposure of directors to leadership positions, and can heighten their overall understanding of the bank’s business.  It also brings a fresh perspective and approach to the committees.  Leadership ability and the commitment of time and energy should be the main criteria for selecting committee chairs.

Do the Europeans have it right?


global.jpgEuropean bank boards, it turns out, are a lot different than in the U.S.  A study earlier this year by the English bank consultancy Nestor Advisors compared nine of the largest European banks with their nine counterparts in the U.S. (e.g. Banco Santander versus U.S. Bancorp and Wells Fargo & Company). Here is what the firm found:

  • U.S bank boards tend to have older members. The median age is 63 compared to 59 on the European boards.
  • U.S. bank boards have fewer designated financial experts than European boards. The difference is 30 percent of board members on European banks versus 15 percent in the U.S.
  • Six out the largest nine U.S. banks have chairmen who also serve as the bank’s CEO, compared to only two of their European counterparts (BBVA and Société Générale).
  • U.S. non-executive directors are more often senior executives at other institutions than in Europe. The median number of non-executive directors with outside senior-level jobs is five in the U.S. versus three in Europe.
  • U.S. bank boards pay their directors with more stock options and less cash than European boards.

By reading the report, you could almost conclude that European banks do a better job following best practices in corporate governance than U.S. bank boards.

Paying stock options could encourage more risk taking, the firm notes. Financial experts might be better qualified to challenge management on matters than impact the bank. Directors who are busy with outside jobs have less time for the bank’s business, presumably.

However, the report notes that large U.S. bank boards tend to be smaller than European bank boards. (The median is 13 directors in the U.S. versus 16 in Europe.) That can encourage more cohesiveness and ability to get work done. U.S. banks tend to have fewer executives and more non-executive directors on the board than European banks. (The median U.S. big bank has 85 percent non-executive directors versus 69 percent for big European banks).

Whether or not these significant differences in board structure translated into any meaningful value for shareholders, or meant European banks avoided the financial crisis better than American banks is another question. (Interestingly, one of the U.S. banks in the study, Goldman Sachs, previously was an investment bank and wasn’t even regulated as a bank before the financial crisis).

Europe is still embroiled in its own problems with an overheated housing market, just like the United States. The Spanish bank bailout fund alone has committed the equivalent of $14 billion in today’s U.S. dollars to recapitalize banks there.

Europe hasn’t recovered yet from its financial hangover, and neither has the United States.