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.