Embracing a Challenging Environment to Evolve

New York University economist Paul Romer once said, “A crisis is a terrible thing to waste.”

With a nod to Dr. Romer, we believe banks have an extraordinary opportunity to embrace the challenging environment created by the Covid-19 pandemic to enhance critical housekeeping matters. Here are five areas where banks may find opportunities to declutter or reengineer policies, procedures and best practices.

Culture
One of the most obvious opportunities for banks is to focus on culture. Employees working from home has eliminated the ability to have typical office parties, barbeques and other events to build comradery. Remote and semi-remote working environments are challenging employees in many difficult ways. Fortunately, banks are finding simple, yet creative, ways to stay in contact with their employees and build culture through additional correspondence and feedback — electronic happy hours, car parades, and socially distant visits, for example. Creatively maintaining high engagement in challenging times will serve to improve communication and culture over the long term. As management consultant Peter Drucker once said, “Culture eats strategy for breakfast.”

Cybersecurity
Cybersecurity risk continues to be top of mind for bankers and regulators given the remote work brought on by Covid. Certainly, most banks’ cybersecurity risk management planning did not contemplate the immediate scale of remote work, but the extreme experience is an opportunity to drill down on underlying policies and procedures. Banking agencies have provided the general blueprint on sound risk management for cybersecurity.

This heightened risk environment provides executives with a perfect opportunity to note where their vulnerabilities may exist or be discovered, where cyberattacks focus and what works—or doesn’t —for your bank. Use the guidance provided to assess your bank’s response and resilience capabilities. Consider the overall map and configuration of your cyber architecture. Consider authentication requirements and permissions to protect against unauthorized access. Take the time to work with information technology experts to clean up access controls and response plans. This is an active situation that provides bankers the unique opportunity to learn and adapt in real time.

Compliance
Banks also face enhanced compliance originating from federal programs aimed at keeping businesses afloat. A worthy endeavor to be sure, but the rollout of some federal programs such as the Small Business Administration’s Paycheck Protection Program has far outpaced the guidance for banks tasked with implementation. The trickle of (often inconsistent) guidance on the documentation, eligibility and certification adds compliance challenges in reporting under the Bank Secrecy Act, fair lending under the Equal Credit Opportunity Act and unfair or deceptive acts and practices under the Federal Trade Commission Act, for example.

Compliance teams have an opportunity to shine at something they are already extraordinarily good at: documentation. They should document the processes and practices they deploy to demonstrate compliance, despite the uncertainty and pace at which they are expected to operate. This documentation can support real-time decision-making that may come up with regulators in the future, and can serve as a basis for improvement on future best practices and training. Compliance teams will discover new questions to ask, novel scenarios to address and gaps to fill.

Operational Planning
The best time to consider the impacts of Covid on your bank’s operations is while events and memories are fresh. Banks all over the country are experiencing what a handful of institutions may go through in the wake of a natural disaster: devastation, uncertainty and a need for banking support. This is the time to review your bank’s disaster recovery and business continuity plans, specifically including pandemic planning, to assess the plans against reality.  

To help, the Federal Financial Institutions Examination Council released an updated statement on pandemic planning suggesting actions that banks can take to potentially minimize a pandemic’s adverse effects. This is an chance to improve business continuity planning for similar future events, understanding that they may not be as deep or prolonged as the coronavirus. Exercising the plans in real time, compared to a scheduled test, can reveal helpful improvements that will only strengthen the bank.

Customer Experience
Coping with remote work and providing banking services outside of a branch provides the opportunity for banks to consider strategies around technology and financial technology partnerships. Customers have been rerouted to electronic avenues, and many seem to have embraced technology to deposit checks, access accounts online and transact business.

This evolution offers banks the opportunity to adapt and recognize the use of financial technologies. Many customers will understandably return to branches to conduct some of their business when they reopen, but may require them less. Banks may want to consider how they can satisfy future customer demand and improve the customer experience more broadly. These are just five areas where we see opportunities for banks of all levels and complexity to enhance their policies, procedures and best practices as they prepare to move forward.

The Biggest Priorities for Banks in Normal Times

Banks are caught in the midst of the COVID-19 pandemic sweeping across the United States.

As they care for hurting customers in a dynamic and rapidly evolving environment, they cannot forget the fundamentals needed to steer any successful bank: maintaining discipline in a competitive lending market, attracting and retaining high-quality talent and improving their digital distribution channels.

Uncovering bankers’ biggest long-term priorities was one of the purposes of a roundtable conversation between executives and officers from a half dozen banks with between $10 billion and $30 billion in assets. The roundtable was sponsored by Deloitte LLP and took place at Bank Director’s annual Acquire or Be Acquired conference at the end of January, before the brunt of the new coronavirus pandemic took hold.

Kevin Riley, CEO of First Interstate BancSystem, noted that customers throughout the $14.6 billion bank’s western footprint were generally optimistic prior to the disruption caused by the coronavirus outbreak. Washington, Oregon and Idaho at the time were doing best. With trade tensions and fear of an inverted yield curve easing, and with interest rates reversing course, businesses entered 2020 with more confidence than they entered 2019.

The growth efforts reflect a broader trend. “In our 2020 M&A Trends survey, corporate respondents cited ‘efficiency and effectiveness in change management’ and ‘aligning cultures’ as the top concerns for new acquisitions,” says Liz Fennessey, M&A principal at Deloitte Consulting.

A major benefit that flows from an acquisition is talent. “More and more, we’re seeing M&A used as a lever to access talent, which presents a new set of cultural challenges,” Fennessey continues. “In the very early stages of the deal, the acquirer should consider the aspects core to the culture that will help drive long-term retention in order to preserve deal value.”

One benefit of the benign credit environment that banks enjoyed at the end of last year is that it enabled them to focus on core issues like talent and culture. Tacoma, Washington-based Columbia Banking System has been particularly aggressive in this regard, said CEO Clint Stein.

The $14.1 billion bank added three new people to its executive committee this year, with a heavy emphasis on technology. The first is the bank’s chief digital and technology officer, who focuses on innovation, information security and digital expansion. The second is the bank’s chief marketing and experience officer, who oversees marketing efforts and leads both a new employee experience team and a new client experience team. The third is the director of retail banking and digital integration, whose responsibilities include oversight of retail branches and digital services.

Riley at First Interstate has employed similar tactics, realigning the bank’s executive team at the beginning of 2020 to add a chief strategy officer. The position includes leading the digital and product teams, data and analytics, as well as overseeing marketing, communications and the client contact center.

The key challenge when it comes to growth, particularly through M&A, is making sure that it improves, as opposed to impairs, the combined institution’s culture. “It is important to be deliberate and thoughtful when aligning cultures,” says Matt Hutton, a partner at Deloitte. “It matters as soon as the deal is announced. Don’t miss the opportunity to build culture momentum by reinforcing the behaviors you expect before the deal is complete.”

Related to the focus on growth and talent is an increasingly sharp focus on environmental, social and governance issues. For decades, corporations were operated primarily for the benefit of their shareholders — a doctrine known as shareholder primacy. But this emphasis has begun to change and may accelerate alongside the unfolding health crisis. Over the past few years, large institutional investors have started promoting a more inclusive approach known as stakeholder capitalism, requiring companies to optimize returns across all their stakeholders, not just the owners of their stock.

The banks at the roundtable have embraced this call to action. First National Bank of Omaha, in Omaha, Nebraska, publishes an annual community impact report, detailing metrics that capture the positive impact it has in the communities it serves. Columbia promotes the link between corporate social responsibility and performance. And First Interstate, in addition to issuing an annual environmental, social and governance report, has taken multiple steps in recent years to improve employee compensation and engagement.

Despite the diversity of business lines and geographies of different banks, these regional lenders shared multiple common priorities and fundamental focuses going into this year. The coronavirus crisis has certainly caused banks to change course, but there will be a time in the not-too-distant future when they and others are able to return to these core focuses.

Talking Too Much About Board Diversity

A backlash has emerged in response to diversity and inclusion initiatives.

In the past several years, activists, institutional investors and some companies — including banks — have advocated for increased diversity and inclusion on their boards and throughout their firms. These groups believe that a diversity of race, gender, age and opinion is good for business and, ultimately, for shareholders.

But two recent studies draw attention to a burgeoning backlash to these efforts. Whether from message fatigue or concern about the board’s focus, companies may need to be mindful about the promotion and communication of their D&I efforts.

Director support to increase gender and racial diversity in the boardroom fell for the first time since 2013 in PwC’s 2019 governance survey. Thirty-eight percent of directors said gender diversity was very important in 2019, down from 46% in 2018. Those who said racial and ethnic diversity was very important fell to 26%, down from 34% the year prior.

Directors seem to be fatiguing of these messages, says Paula Loop, leader of PwC’s Governance Insights Center, who adds she was surprised at the recent trend.

“The way that we rationalized it is that it appears that directors have heard the message and they’re trying to acknowledge that,” she says.

Respondents to PwC’s survey acknowledged that diversity has added value to their discussions and decisions, Loop says, and that it increasingly makes sense from a business perspective. This finding is supported more broadly: Bank Director’s 2018 Compensation Survey found that 87% of respondents “personally believe” that board diversity, either through age, race or gender, has a positive impact on the bank’s performance.

“We have to remember, especially when you’re thinking about boards, they … don’t move necessary as quickly as one might think,” Loop says. “I feel like we’re in an evolution — but there’s been a lot in the last couple of years.”

Interestingly, PwC observed different responses to the survey based on the gender of respondents. A higher percentage of female directors reported that gender and racial/ethnic diversity on the board was “very important.” Male directors were less inclined to report seeing evidence of the benefits of diversity, and more than half agreed that diversity efforts “are driven by political correctness.”

Male directors were three times as likely as a female director to assert that investors “devote too much attention” to both gender and racial/ethnic diversity. Overall, 63% of directors believe investors are too focused on gender diversity, up from 35% in 2018; 58% report the same when it comes to racial/ethnic diversity, up from 33%.

The different responses along gender lines demonstrates why diversity matters, Loop says. The report shows that gender-diverse slate of directors do have a “different emphasis or different way of thinking.”

“It validates why it’s good to have a diverse group of people in a room when you have a conversation about an important issue,” she says.

But even if a bank makes headway on increasing the gender diversity on its board, there is still another group to think about: shareholders. A recent study found that companies that appoint women to the board experience a decline in their share price for two years after the appointment. The study looked at more than 1,600 U.S. companies between 1998 and 2011.

“Investors seem to be penalizing, rather than rewarding, companies that strive to be more inclusive,” wrote INSEAD researchers Isabelle Solal and Kaisa Snellman in a November 2019 Harvard Business Review article about their study.

What we think is happening is that investors believe that firms who choose to appoint women are firms who care more about diversity than about maximizing shareholder value,” writes Solal, a postdoctoral research fellow at the Stone Centre for the Study of Wealth Inequality at INSEAD, in an email interview.

In subsequent research, they found that investors view appointments of female directors with a company’s “diversity motivation.” The association is “not that surprising,” she writes, given that “almost all” press releases feature the gender of the appointee when that person is a woman, and will often include other references to diversity.

“Gender is never mentioned when the director is a man,” she writes.

Solal says that companies should still appoint women to their boards, especially given that the shareholder skepticism dissipates in two years. But companies should be mindful that overemphasizing a director’s gender or diversity may be unhelpful, and instead highlight the “skills and qualifications of their candidates, regardless of their gender.”

Two-Thirds of Bank Directors Are Worried About the Same Thing


risk-6-12-19.pngAt around a quarter to seven o’clock on the evening of Saturday, May 11, firefighters showed up at Enloe State Bank in Cooper, Texas, to find a stack of papers on fire on the conference room table.

“We believe it is suspicious,” said the sheriff, “but we don’t have any more information at this point.” Three weeks later, regulators seized the bank “due to insider abuse and fraud by former officers,” according to Texas Banking Commissioner Charles Cooper.

It’s fair to say that Enloe State Bank is an outlier. It was the first bank to fail in a year and a half, in fact. And one can’t help but wonder what would lead someone to set papers ablaze on a conference room table.

Yet, incidents like this are important for bank executives and directors to register, because they underscore the importance of proactive oversight by a bank’s board—especially the audit and risk committees.

“The essence of the audit committee’s responsibilities is protecting the bank,” said Derrick Hong, the chief audit executive at Pacific Premier Bank, at Bank Director’s 2019 Bank Audit & Risk Committees Conference taking place in Chicago this week. “There are so many pitfalls and risks that could potentially take down a bank, so focusing on those things is the key responsibility of the audit committee.”

Admittedly, it seems like an odd time to worry about risk.

Bank capital levels have never been stronger or of higher quality, noted Steven Hovde, chairman and CEO of Hovde Group. Net charge-offs are lower across the industry than they’ve been in decades. And tax reform has catalyzed profitability. Despite narrow lending margins and subpar efficiency, the banking industry is once again earning more than 1 percent on its assets, exceeding the benchmark threshold last year for the first time since the financial crisis.

But it’s in the good times like these that banking’s troubles are sowed.

“You have to be proactive rather than reactive,” said Mike Dempsey, senior manager at Dixon Hughes Goodman LLP. This approach stems from culture, said Dempsey’s co-presenter LeAnne Staalenburg, senior vice president in charge of corporate security and risk at Capital City Bank Group.

“Culture is key,” said Stallenburg. “Having that culture spread throughout the organization is critical to having a successful risk management program.”

To be clear, the biggest threat to banks currently isn’t bad loans. Credit policy isn’t something to ignore, of course, because loan losses will climb when the cycle takes a turn for the worse. But banks have plenty of capital to absorb those losses, and memories of the last crisis are still fresh in many risk managers’ minds.

The biggest threat isn’t related to funding, either. Even though bankers are concerned about large institutions taking deposit market share as interest rates climb, 74 percent of attendees at Bank Director’s Audit & Risk Committees Conference said their institutions either maintained their existing share or gained share as rates inched higher.

Instead, according to conference attendees, the biggest threat is related to technology. When asked which categories of risk they were most concerned about, 69 percent identified cybersecurity as the No. 1 threat.

Vendor relationships only aggravate this concern. As Staalenburg and Dempsey noted in response to an attendee’s question, vendors offer another way for malicious actors to infiltrate a bank.

Even though we are in a golden age of banking, Hovde emphasized, now is not the time for a bank’s board, and particularly its audit and risk committees, to be complacent.

“Generally, we have seen that the institutions that are well run and have fewer problems are under the oversight of an engaged and well-informed board of directors,” wrote Kansas City Federal Reserve President Esther George in the Fed’s governance manual, Basics for Bank Directors. “Conversely, in cases where banks have more severe problems and recurring issues, it is not uncommon to find a disengaged board that may be struggling to understand its role and fulfill its fiduciary responsibilities.”