ESG Principles at Work in Diversifying Governance

Before environmental, social, and governance (ESG) matters became commercially and culturally significant, the lack of diversity and inclusion within governance structures was noted by stakeholders but not scrutinized.

The shifting tides now means that organizations lacking diversity in their corporate leadership could be potentially subjected to shareholder lawsuits, increased regulation and directives by state laws, investment bank requirements, and potential industry edicts.

Board and management diversity is undoubtedly a high-priority issue in the banking and financial services sectors. Numerous reports establish minority groups have historically been denied access to capital, which is mirrored by the lack of minority representation on the boards of financial institutions.

Some progress has been made. For example, for the first time in its 107-year history, white men held fewer than half of the board seats at the Federal Reserve’s 12 regional outposts. This was part of an intentional effort, as Fed leaders believe a more representative body of leaders will better understand economic conditions and make better policy decisions. However, further analysis reflects such diversity predominantly among the two-thirds of directors who are not bankers, while the experienced banking directors are mainly white males.

Board Diversity Lawsuits
The current pending shareholder suits have been primarily filed by the same group of firms and targeted many companies listed by a recent Newsweek article as not having a Black director. None of these suits involve financial institutions, but it is not hard to foresee such cases coming in the future. The lawsuits generally assert that the defendants breached their fiduciary duties and made false or misleading public statements regarding a company’s commitment to diversity. The Courts have summarily dismissed at least two suits, but a legal victory may not even be the goal in some cases.

Recently, Google’s parent settled its #MeToo derivative litigation and agreed to create a $310 million diversity, equity, and inclusion fund to support global diversity and inclusion initiatives within Google over the next ten years. The fund will also support various ESG programs outside Google focused on the digital and technology industries.

Regulatory, Industry, and Shareholder Efforts
Federal and state regulatory efforts preceded these recent lawsuits. The U.S. Securities and Exchange Commission has issued compliance interpretations advising companies on the disclosure of diversity characteristics upon which they rely when nominating board members and is expected to push more disclosure in the future. Additionally, the U.S. House of Representatives considered a bill in November 2019 requiring issuers of securities to disclose the racial, ethnic, and gender composition of their boards of directors and executive officers and any plans to promote such diversity.

These efforts will likely filter into boardrooms and may spur additional board regulation at the state level. In 2019, California became the first state to require headquartered public companies to have a minimum number of female directors or face sanctions, increasing 2021. In June 2020, New York began requiring companies to report how many of their directors are women. As other states follow California’s lead regarding board composition, we can expect more claims to be filed across the country.

At the industry level, the Nasdaq stock exchange filed a proposal with the SEC to adopt regulations that would require most listed companies to elect at least one woman director and one director from an underrepresented minority or who identify as LGBTQ+. If adopted, the tiered requirements would force non-compliant companies to disclose such failures in the company’s annual meeting proxy statement or on its website.

In the private sector, institutional investors, such as BlackRock and Vanguard Group, have encouraged companies to pursue ESG goals and disclose their boards’ racial diversity, using proxy votes to advance such efforts. Separately, Institutional Shareholder Services and some non-profit organizations have either encouraged companies to disclose their diversity efforts or signed challenges and pledges to increase the diversity on their boards. Goldman Sachs Group has made clear it will only assist companies to go public if they have at least one diverse board member.

Concrete Plans Can Decrease Director Risk
Successful institutions know their diversity commitment cannot be rhetorical and is measured by the number of their diverse board and management leaders. As pending lawsuits and legislation leverage diversity statements to form the basis of liability or regulatory culpability, financial institutions should ensure that their actions fully support their diversity proclamations. Among other things, boards should:

  • Take the lead from public and private efforts and review and, if necessary, reform board composition to open or create seats for diverse directors.
  • When recruiting new board members, identify and prioritize salient diversity characteristics; if necessary, utilize a diversity-focused search consultant to ensure a diverse pool of candidates.
  • Develop a quantifiable plan for diversity issues by reviewing and augmenting governance guidelines, board committee efforts, and executive compensation criteria.
  • Create and promote diversity and inclusion goals and incorporate training at the board and management levels.
  • Require quarterly board reporting on diversity and inclusion programs to reveal trends and progress towards stated goals.

As companies express their commitment to the board and C-level diversity and other ESG efforts, they should create and follow concrete plans with defined goals and meticulously measure their progress.

2021 Governance Best Practices Survey Results: Who’s Driving Bank Strategy?

The best banks balance short-term thinking with long-term strategy.

“Long-term performance is always our paramount objective,” Bank OZK Chair and CEO George Gleason told Bank Director at its recent Inspired by Acquire or Be Acquired virtual event. The $27 billion bank topped Bank Director’s 2021 RankingBanking study. “If short-term results suffer because of our focus on long-term objectives, then that’s just part of it.”

Strategic discipline starts with a bank’s leadership team — and the board should play an important role in developing the strategy and monitoring its execution. But that’s not always the case, according to the results of the 2021 Governance Best Practices Survey, sponsored by Bryan Cave Leighton Paisner LLP.

The survey explores the board’s approach to strategic planning, as well as governance practices, board composition and the relationship between executives and the board. The results find that most boards don’t drive strategic planning at their institutions: Just 20% say the board drives this process and collaborates with management to develop the strategic plan. Most — 56% — say their board establishes the risk appetite but relies on management to develop the strategy.

The vast majority believe their strategic planning process is effective. But of the 11% who believe their process to be ineffective, some express regret over the lack of input from their board. One respondent believes their bank’s strategic plan to be “too in the weeds,” while another holds the opposite concern. “It flies at 30,000 feet for [the] most part,” says one independent chair. “[We] need to get a little closer to the ground with metrics and clear paths for management to build.”

Most — 84% — reviewed their strategic plan during the pandemic, but few shortened the time horizon of their strategy. This may seem surprising, given previous indicators that Covid-19 accelerated bank strategy in some areas, particularly around the implementation of digital technology. Perhaps this indicates that, for most bank leadership teams, balancing short-term results and long-term strategy remains top of mind.

Key Findings

Strategic Review
Three-quarters of respondents say their board reviews the strategic plan annually. Roughly two-thirds bring in an outside advisor or consultant to assist in developing the strategic plan — but not generally every year.

Board Responsibilities
When asked to identify the board’s most important functions, the majority of respondents point to holding management accountable for achieving goals in a safe and sound manner (61%) and meeting its fiduciary responsibilities to shareholders (60%). Just 34% say that setting strategy is a key board responsibility.

Competitive Pressures
Respondents say that pressure on net interest margins (52%), the ability to grow organically in their markets (44%) and meeting customer demands for digital options (37%) threaten the long-term viability of their bank.

Interacting With Management
The vast majority of independent directors, chairs and lead directors believe they’re getting the right level of information from bank executives. Almost all interact at least quarterly with the bank’s CEO (98%), CFO (94%) and chief risk officer (85%).

Credible Challenge
Three-quarters say their board has several directors willing to ask tough questions when warranted; 92% find their management team receptive to feedback.

Needle Moving on Board Diversity
Almost 60% believe that fostering diversity in the boardroom improves corporate performance. Thirty-nine percent have three or more board members who bring diverse characteristics to the board, based on gender, race or ethnicity.

Assessing Performance
Less than half conduct an annual evaluation of their board’s performance, which most use to assess the effectiveness of the board as a whole (84%), improve governance processes (60%), identify training needs for the board (59%) or assess committee performance (58%).

To view the full results of the survey, click here.

Why ESG Will Include Consumer Metrics

Imagine a local manufacturer, beloved as an employer and a pillar of the community. The company uses 100% renewable energy and carefully manages its supply chain to be environmentally conscious. The manufacturer has a diverse group of employees, upper managers and board. It pays well and provides health benefits. It might be considered a star when it comes to environmental, social and governance (ESG) parameters.

Now imagine news breaks: Its product causes some customers to develop cancer, an outcome the company ignored for years. How did a good corporate citizen not care about this? You could say this was a governance failure. Everyone would agree that it was a trust-busting event for customers.

ESG, at its root, is about looking at the overall impact of a company. The most profound impact of banks is the impact of banking products. Most bank products are built for use in a perfect world with perfect compliance, but perfect compliance is hard for some people. Noncompliance disproportionately affects the most vulnerable customers ⎯ people living paycheck-to-paycheck and managing their money with little margin to spare. That isn’t to say that these individuals are all under or near the poverty line: Fully 18% of people who earn more than $100,000 say they live paycheck to paycheck, according to a survey of 8,000 U.S. workers by global advisory firm Willis Towers Watson. There is growing recognition that bank products need to reflect the realities of more and more Americans.

Years ago, Columbus, Ohio-based Huntington Bancshares started working on better overdraft solutions for customers whose financial lives were far from perfect. Currently, the $123 billion regional bank will not charge for overdrafts under $50 if a customer automatically deposits their paycheck. If the customer overdrafts $50 or more, the bank sends them an alert to correct it within 24 hours.

Likewise, Pittsburgh-based PNC Financial Services Group recently announced a new feature that gives PNC Virtual Wallet customers 24 hours to cure an overdraft without having to pay a fee.  If not corrected, an overdraft amounts to a maximum of $36 per day.

“With this new tool, we’re able to shift away from the industry’s widely used overdraft approach, which we believe is unsustainable,” said William Demchak, chairman and CEO of the $474 billion bank, in a statement. The statement alone reframes what sustainability means for banking.

The banks that become ESG leaders will create products that improve the long-term financial health of their retail and small businesses customers. To do so, some financial institutions are asking their customers to measure their current financial realities in order to provide better solutions.

For example, Credit Human, a $3.2 billion credit union in San Antonio, is putting financial health front and center both in their branches and digitally. Their onboarding process directs individuals to a financial health analysis supported by FinHealthCheck, a data tool that helps banks and credit unions measure the financial health of customers and the potential outcomes of the products they offer. The goal of Credit Human is to improve the financial health of their customers and eventually make it a part of the overall measurement of the product’s performance.

Measurement alone will not build better bank products. But it will provide banks and credit union executives with critical information to align their products with customer well being. With the implementation of overdraft avoidance programs such as PNC’s Low Cash Mode, the bank expects to help its customers avoid approximately $125 million to $150 million in overdraft fees annually. PNC benefits its bottom line by driving more customers to its Virtual Wallet, nabbing merchant fee income and creating customer loyalty in the process. PNC’s move makes it clear that they believe promoting the long-term financial health of their customers promotes the long-term financial health of the company.

Banks need to avoid appearing to care about ESG, while failing to care about customers. The banks that include customer financial health in their ESG measurement will survive, thrive and become the true ESG stars.

ESG: Walk Before You Run

Covid-19 and last year’s protests over racial injustice added to the mounting pressure corporations face to make progress on environmental, social and governance (ESG) issues — but banks may be further ahead than they believe.

“ESG took on a life of its own in 2020,” says Gayle Appelbaum, a partner at the consulting firm McLagan. Institutional investors have slowly turned up the heat on corporate America, along with community groups, proxy firms and ratings agencies, and regulators such as the Securities and Exchange Commission, which now mandates a human capital management disclosure in annual reports. Customers want to know where companies stand. Prospective employees want to know if a company shares their values. And President Joe Biden’s administration promises to focus more on social and environmental issues.

Big banks like Bank of America Corp. and JPMorgan Chase & Co. have been responding to these pressures, but now ESG is trending down through the industry. With the right approach, banks may find that these practices actually improve their operations. However, smaller community and regional banks can’t — and probably shouldn’t — merely copy the ESG practices of their larger brethren. “People have to think about what’s appropriate for their bank, given [its] size and location,” says Appelbaum. “What are they already doing that they could expand and beef up?”

That means banks shouldn’t feel pressured to go big or go home when it comes to ESG. Begin with the basics: Has your bank reduced waste by encouraging paperless statements? How many hours do employees spend volunteering in the community? “When you sit down and talk to bankers about this, it’s interesting to see [their] eyes open,” says Brandon Koeser, senior manager and financial services senior analyst at the consulting firm RSM. The pandemic shed light on how banks support their employees and communities. “The reality is, so much of what they’re doing is part of ESG.”

Robin Ferracone, CEO of the consultancy Farient Advisors, tells companies to think of ESG as a journey, one that keeps strategy at its core. “You need to walk before you run. If you try to bite [it] all off at once, you can get overwhelmed,” she says. Organizations should prioritize what’s important to their strategy and stakeholders. ESG objectives should be monitored, revisited and adjusted along the way.

Stakeholders are watching. Glacier Bancorp CEO Randall Chesler was surprised to learn just how closely in a conversation with one of the bank’s large investors two years ago.

“One of our investors asked us, ‘Have you looked at this? We see your score isn’t very good; are you aware of that? What are you going to do about it?’ And that was the first time that we started to dig into it and realized that we were being scored by ISS,” says Chesler. (Institutional Shareholder Services provides an ESG rating on companies, countries and bonds to inform investors.)

It turned out that $18.5 billion Glacier was doing a lot, particularly around the social and governance aspects of ESG. The Kalispell, Montana-based bank just wasn’t telling its story. This is a common ESG gap for community and regional banks.

Glacier worked with consultants to develop a program and put together a community and social responsibility report, which is available in the investor relations section of its website, along with other governance documents such as its code of ethics. This provided the right level of information to lift Glacier’s score. “Our benchmark was, we want to be at our peer-level scoring on ESG,” says Chesler. “[We] ended up actually better. And we continue to watch our scores.”

“Community banks have the social and governance aspects covered better than many industries because [banks are] heavily regulated,” says Joe Scott, a managing director at Kroll Bond Rating Agency. Where they likely lag, he says, is around the environment; most are just beginning to assess these risks to their business. And it’s important that banks get this right as stakeholders increasingly focus on ESG. “We’re hearing that, beyond equity and debt investors, larger depositors — particularly corporate depositors, institutional depositors, state treasurers’ officers [and] others like that — are incorporating ESG into their considerations on who they place large deposits with. That could be a theme over time— other kinds of stakeholders factoring in ESG more and more.”

Four Essential Governance Practices

Bank Director’s 2020 Governance Best Practices Survey, sponsored by Bryan Cave Leighton Paisner, focused on how bank boards manage their business, including their composition, independence and oversight. The analysis also digs into some key best practices, which Bryan Cave Partner James McAlpin Jr. explores further in this video.

  • Meeting Frequency
  • Appointing a Lead Director
  • Building Diversity
  • Assessing the Board

What We’ve Learned From the Pandemic (So Far)

Year in and year out, Bank Director’s surveys tap into the views of bank leaders across the country about critical issues: risk, technology, compensation and talent, corporate governance, and M&A and growth.

But 2020 has been a year for the record books. It’s been an interesting time for me as head of research for Bank Director, with the results of our recent surveys revealing changes that, in my view, will continue to have far-ranging effects for the industry.

As boards plan for 2021 and beyond, here are a few things I believe you should be considering.

The Great Tech Ramp-Up
The Covid-19 pandemic dramatically accelerated technology adoption by the industry, an issue we explored in Bank Director’s 2020 Technology Survey.

Sixty-five percent of the executives and board members responding to that survey told us that their bank implemented or upgraded technology to respond to Covid-19, primarily to issue Paycheck Protection Program loans. As a result, most banks reported increased spending on technology, above and beyond their budgets for 2020.

The primary drivers that fuel bank technology strategies remain the same — improving customer experience and generating efficiencies — and pressure has only grown on financial institutions to adapt. More than half of the survey respondents told us that their bank’s technology plans had been adjusted due to the pandemic, with most focused on enhancing their digital banking capabilities.

“The next generation will rarely use a branch,” one survey respondent commented, “so a totally quick efficient comprehensive digital experience will be necessary to survive.”

The 2020 Compensation Survey confirmed that most banks dialed back on branch service early in the pandemic; by the time we fielded the Technology Survey in June and July, bank leaders finally recognized the digital channel’s preeminence in terms of growing the bank and serving customers. (The previous year’s survey found respondents placing equal emphasis on digital and branch channels.)

Our FinXTech Special Report on mobile banking provides tips on evaluating your bank’s mobile app.

The Technology Survey revealed gaps in small business and commercial lending as well — deficiencies that have been laid bare as a result of the pandemic. More than half of respondents that have adjusted or accelerated their technology strategy indicated they’d expand digital lending capabilities.

Some bankers I spoke with about the survey results indicated concerns that banks could dial back on technology spending due to the profitability pressures facing the industry. However, given the changes we’ve seen, I don’t believe it’s sustainable to dial back on this investment.

That leaves bank leaders facing a few key challenges, starting with determining where to invest their technology dollars. It’s difficult to gauge where the wind will blow, but the survey provides solid clues: 42% believe process automation will be one of the most important technologies affecting their bank, followed by data analytics (39%). Almost 40% believe the security structure to be vitally important; cybersecurity is a perennial concern for bank leaders and as banking grows more digital, this will require additional investment.

Additionally, 64% told us that modernizing their bank’s digital applications forms a core element of their bank’s strategy.

Implementing new technology requires expertise, and the 2020 Compensation Survey found most respondents (79%) telling us that it’s difficult to attract technology and digital talent.

But this may not mean bringing data scientists or other highly-specialized roles on staff. Olney, Maryland-based Sandy Spring Bancorp hired a senior data strategist who is responsible for the use, governance and management of information across the organization; that individual also reviews vendor capabilities and identifies areas that help the bank achieve its goals. “The senior data strategist should be on the lookout for ways to find opportunities for and through data analytics, whether that’s predicting customer trends or finding new revenue-generating opportunities,” said John Sadowski, chief information officer at the $13 billion bank.

Finally, 69% told us their bank didn’t streamline vendor due diligence processes in response to Covid-19. As technology adoption accelerates, consider whether your bank’s third-party management process is sufficiently comprehensive, while still allowing it to quickly and efficiently put new solutions into place. 

Work-From-Home Will Alter the Workplace
The 2020 Compensation Survey found that banks almost universally implemented or expanded remote work options as a result of the pandemic; the 2020 Technology Survey later told us that for many banks (at least 42%) that change will be permanent for at least some of their staff.

In late October, $96 billion Synchrony Financial — a direct, virtual bank — announced that remote work will become permanent for its employees, allowing them to choose from three options. Some can simply work from home. Others can schedule office space, while some will have an assigned desk. This third group includes executives, who will be asked to work remotely at least a couple days a week to reinforce the cultural shift.

It’s a move that the bank believes will make employees happy, but it also promises to yield significant cost savings by cutting real estate expenses.

It could also yield competitive benefits for banks seeking top talent. Glacier Bancorp, for example, doesn’t limit hires to its Kalispell, Montana-based headquarters — instead, it hires anywhere within its multi-state footprint. That helps the $18 billion bank recruit the technology talent it needs, human resources director David Langston told me in May.

Remote work is a cultural shift that many bank executives will be reticent to make. But even if a long-term remote work option doesn’t align with your bank’s culture, offering flexibility will help support employees, who have their own struggles at home with virtual schooling or caring for high-risk family members.

Too often, working parents are forced to choose between their children and their career, meaning companies are losing valuable employees or, in the least, productivity.

A recent McKinsey study finds that a lack of flexibility, among other issues, drives women in particular to leave the workforce. The authors also advise that companies “should look for ways to re-establish work-life boundaries” — putting policies in place to assure meeting times and work communications occur within set hours, and encouraging employees to take advantage of flexible scheduling. Unfortunately, employees often worry that taking advantage of these benefits will damage their reputation at work. “To mitigate this, leaders can assure employees that their performance will not be measured based on when, where, or how many hours they work. Leaders can also communicate their support for workplace flexibility [and] can model flexibility in their own lives. … When employees believe senior leaders are supportive of their flexibility needs, they are less likely to consider downshifting their careers or leaving the workforce.”

Flexibility and remote work can help companies retain valued employees.

It’s difficult to change a culture, especially if you believe that what you’re doing works. But sometimes, culture can change around you.  I’d encourage you to approach these issues with fresh eyes to ensure your leadership team can direct the change — not the other way around.

Don’t Put Diversity on the Backburner
Almost half of respondents to Bank Director’s 2020 Compensation Survey told us their bank doesn’t measure its progress around diversity and inclusion, indicating to me that they don’t have clear objectives around creating an inclusive culture that hires, retains and rewards employees despite race, ethnicity or gender.

Further, just 39% of the CEOs and directors responding to our 2020 Governance Best Practices Survey told us their board has several members who are diverse, based on race, ethnicity or gender. And almost half believe that diversity’s impact on a company’s performance is overrated.

Employees and customers take this issue seriously. Rockland, Massachusetts-based Independent Bank Corp., which has been recognized for LGBTQ workplace equality by the Human Rights Campaign since 2016, incorporates inclusion in its “cycle of engagement.” This starts with engaged employees who provide a higher level of service that delights customers, resulting in strong financial performance for the institution, allowing the company to invest back into its employees — continuing the virtuous cycle.

The $13 billion bank’s culture promotes respect, teamwork, empathy — and inclusion, COO Robert Cozzone told me in a recent interview. “Think about working for a company where you enjoy being around the people that you work with, you enjoy the work that you do, you buy into the mission of the company — you’re going to be much more productive than if you don’t have those things,” he says. Today, “It’s all that more important to show [employees] care and empathy and understanding.”

Small, rural banks may believe it’s difficult to hire diverse talent, making it nearly impossible for them to tackle this issue. Expanding remote work options, mentioned earlier, can help. But ultimately, it’s an issue that companies nationwide will need to address as the demographics of the country change. “We all need to do better [on] diversity and inclusion,” one survey respondent wrote. “Many of us out in rural America don’t have as many opportunities, but we need to keep this topic front of mind, and [read] information and stories on how to be more intentional.”

Directors Must Be Engaged and Educated
The 2020 Governance Best Practices Survey also found 39% indicating that at least some members of their board aren’t actively engaged in board meetings; 36% said some members don’t know enough about banking to provide effective oversight.

That survey, conducted just before the pandemic effectively shut down the U.S. economy, found executives and directors identifying three top challenges to the viability of their institution: pressure on net interest margins (53%), meeting customer demands for digital options (40%) and industry consolidation and the growing power of big banks. Further, most directors said that staying on top of the changes occurring in the industry is one of the great challenges facing their board.

Confronting these issues will require engaged and knowledgeable leadership.

Bank Director’s 2020 Compensation Survey, sponsored by Compensation Advisors, surveyed 265 independent directors, CEOs, human resources officers and other senior executives of U.S. banks to understand trends around the acquisition of talent, CEO performance and pay, and director compensation. The survey was conducted in March and April 2020.

Bank Director’s 2020 Technology Survey, sponsored by CDW, surveyed more than 150 independent directors, CEOs, chief operating officers and senior technology executives of U.S. banks to understand how technology drives strategy at their institutions and how those plans have changed due to the Covid-19 pandemic. It also includes compensation data collected from the proxy statements of 98 public banks. The survey was conducted in June and July 2020.

Bank Director’s 2020 Governance Best Practices Survey, sponsored by Bryan Cave Leighton Paisner, surveyed 159 independent directors, chairmen and CEOs of U.S. banks under $50 billion in assets to understand the practices of bank boards, including board independence, discussions and oversight, engagement and refreshment. The survey was conducted in February and March 2020.

Bank Director has published several recent articles and videos about issues related to today’s economic environment. Our Online Training Series includes units on “Managing the Balance Sheet in a Zero-Rate Environment” and “Managing Through the Coronavirus Pandemic.” You may also consider watching Bank Director Editor at Large Jack Milligan’s conversation with Huntington Bancshares CEO Steve Steinour, which focuses on “Strategic Planning in an Age of Uncertainty.”

Our Bank Services membership program also includes licenses to FinXTech Connect, which helps banks identify technology providers. You can find out more about that tool and how to access it here.

Is an Independent Chair a Best Practice?

Independence is a foundational principal in corporate governance.

Many good governance proponents would argue that corporate boards should be comprised primarily of outside directors who meet the legal definition of independence. In laypersons’ terms, this means they are free of any conflicts of interest that would prevent them from discharging their fiduciary responsibilities to the company’s owners.

Likewise, many governance experts would say that splitting the chair and CEO roles between two individuals also is a best practice. In this instance, the chair would be an independent director who focused their attention on managing the board, while the CEO ran the company.

Having an independent chair can be especially helpful when the board has appointed a new CEO who has never held that position before; the chair can focus on board governance while the CEO transitions into their new role. Splitting the jobs can also provide a check on an overbearing CEO who might dominate the board if they were also the chair.

This approach would seem to enhance the board’s independence, but is it a best practice? And does splitting the chair and CEO roles necessarily improve the company’s profitability?

Results from Bank Director’s 2020 Governance Best Practices Survey suggest that most bank boards have a majority of independent directors. The survey included 159 independent directors, chairs and CEOs at banks under $50 billion in assets. It was sponsored by Bryan Cave Leighton Paisner.

Forty-four percent of the survey participants say they have just one inside director on their boards, while 27% have two, 12% have three and 18% have more than three. An inside director is normally a member of management. Survey banks with more than $10 billion in assets were more likely to have just one inside director, while banks under $500 million in assets were more likely to have multiple insiders on their boards.

A majority of survey participants — 58% — have an independent director as their board chair, while the CEO was also the board chair at 31% of the respondents. Interestingly, survey banks under $500 million in assets were more likely to have split the chair and CEO roles (73%), while banks over $10 billion were less likely to have dual roles (50%).

James McAlpin Jr., a Bryan Cave partner who leads the firm’s banking practice group, says that while a combined role can make a difference in a situation where the board has to replace the CEO because of a performance issue, he does not consider it to be a best practice.

“Maybe 10 years ago I would have said, ‘Yes, it is a best practice for the chair not to be the CEO,’ but I have changed my opinion,” McAlpin says. “I do think it absolutely matters who the individual is. And in an instance where you have a well performing and highly respected CEO, it may make the most sense for that person to be the chair because they often want to run the board. And it would be difficult to retain them if they are not the chair.”

McAlpin’s point speaks to a simple truth at most banks: It is the CEO who drives the company’s performance, not the board or an independent chairman. A strong governance culture can certainly have a positive impact on a bank’s financial performance by establishing an effective risk management culture, adopting compensation practices that reward high performance and making sure that a capable CEO is in place. And an independent chairman can provide a CEO with an important sounding board if the two have a good relationship. But the CEO runs the company, not the board or the independent chair.

“I’ve never seen a study of this, but I doubt you would see any statistical advantage in terms of performance for having an independent chair,” McAlpin says. “In fact, it might be the opposite where the banks perform better if the chair and CEO are the same person.”

Greg Carmichael was not given the chairman’s title when he became the CEO at Fifth Third Bancorp, a $203 billion regional bank in Cincinnati, in November 2015.

“When we made the transition to myself as the new incoming CEO, we elevated our lead director to become the chairman for a period of time,” Carmichael explains. “It was decided and voted on when I became CEO that at some point I would become the chairman. And that time frame was roughly two years. They didn’t want to put the burden of the chairman role on me initially, which was appropriate. They also wanted to make sure that I had a chairman in place to help me through that transition to CEO.”

Carmichael was later appointed chairman in January 2018, and he says it was helpful that initially he could just focus his attention on running the company. “When you become a new CEO, you’re drinking from a fire hose and you’re just inundated with a ton of information and there are things you have to demonstrate and manage that take a lot time,” he says. “You have to get your operating rhythm in place. You have to get your credibility with [Wall Street], with your own organization; you have got to chart your vision, what you’re about and where you’re taking the company, and that takes an inordinate amount of time your first couple of years. They didn’t want that to be encumbered by me worrying about the board dynamics and the board meetings and so forth.”

Marsha Williams, Fifth Third’s chair during Carmichael’s early years as CEO, had served on the bank’s board since 2008; prior to her elevation, she had been the board’s lead director for two years. “It was very helpful to me because I had a great relationship with Marsha and it was always just a reassuring conversation or good guidance if there was input on something she thought was important,” he says.

After Carmichael assumed the title of chairman, Williams returned to her previous role as the board’s lead director. Carmichael says they continue to work together well. “There’s probably not a week that goes by that we don’t talk,” he says. “She’s a great sounding board on ideas and thoughts that I have. She’s good at giving me independent feedback from the board [about] things they’d like to hear more about.”

Carmichael’s relationship with Williams highlights the importance of having a lead director when the CEO is also the board chair. Lead directors have less authority than board chairs, but they can help build an important bridge between the CEO and the independent directors.

Unfortunately, of the survey banks that have appointed an independent chair, only 55% have also appointed a lead director. “I think having a lead director is a best practice,” says McAlpin. “It’s important to have someone [the CEO] can talk to without having to talk to the entire board to bounce ideas off. I think it’s important for both the board and the CEO.”

Governance Survey Results: Directors Sound Off on Diversity, Performance

SURVEY.pngU.S. banks have made modest progress on improving the diversity of their boards of directors, but more work needs to be done, based on the results of Bank Director’s 2020 Governance Best Practices Survey.

Sponsored by Bryan Cave Leighton Paisner, the survey was conducted in February and March of this year and included the perspectives of 159 independent directors, chairmen and CEOs of U.S. banks under $50 billion in assets.

Thirty-nine percent of the survey participants say their boards have several diverse directors, based on gender or ethnic and racial backgrounds. Thirty percent have one of two diverse directors but hope to recruit more. Thirteen percent indicate they have one or two diverse directors and believe that is sufficient, while another 13% say they have no such directors and would like to recruit some. And 5% say they have no diverse directors and aren’t seeking to add those attributes.

“What I say to boards is to look at your communities,” says James McAlpin Jr., a partner at Bryan Cave and leader of the firm’s banking practice group. “Many communities in the United States have undergone fundamental demographic change over the last 15 years.” Included in this demographic evolution is an increase in the number of women and minority business owners. “Then look around your board table,” he continues. “I think it’s really important for the board to reflect the bank’s demographic customer base.”

There is a solid body of academic research that diverse boards make better decisions, resulting in stronger financial performance. But not all of the survey’s respondents are on board with that assessment. While 52% agree that diversity improves a board’s performance, 40% believe it does to an extent but the impact is overrated, and 8% do not believe that diversity improves performance.

The survey also finds that a significant number of participants report a lack of engagement by some members of their board, with 39% saying that some or few of their directors are actively engaged during board and committee meetings.

Not unsurprising perhaps, the survey found that a significant number — 42% — report having at least one or two underperforming directors.

McAlpin suggests that engagement and performance issues “need to be addressed through board evaluation and feedback to those directors.” Unfortunately, less than half of the survey participants say their boards perform some type of periodic performance review, and just 31% include individual director assessments in that process.

Other Survey Results Include

  • Fifty-eight percent of the respondents serve on board where the chair is an independent director. On boards where the CEO is also the chair, only 55% have a lead independent director.
  • The median length of board service for the participants is 12 years; 76% are over the age of 60.
  • Eighty-four percent identify as white and 78% as male. Just 1% are Black and 1% are Hispanic.

Click HERE to view the full survey results.

For a further analysis of the findings that examines process, independence, composition, oversight and refreshment, access “How Bank Boards Manage Their Business” HERE.

Cast a Wider Net for Your Next Director

Few factors determine a corporate board’s effectiveness more than its composition, and yet many banks take a slapdash approach to the recruitment of new directors.

Even really good banks are guilty of this. When I asked the independent chairman of a bank that regularly scores well on our annual Bank Performance Scorecard, a performance ranking of the 300 largest publicly owned banks in the country, what his board’s process was for recruiting new directors, he said it really didn’t have one. The board had recruited two new directors recently, including one who was added following an acquisition, but the chairman didn’t want to hold up his board as a model for director refreshment.

Part of the problem is that director succession is not taken seriously enough at many banks, so when a vacancy does occur the board doesn’t have a tested process in place. That sets off a “who do we know” scramble that is reactive rather than proactive.

“Historically, the way most community banks have found directors is through the CEO and possibly through some directors, and it’s in a personal context,” says James J. McAlpin Jr., an Atlanta-based partner at Bryan Cave Leighton Paisner and head of the firm’s banking practice. “It’s people in the community who are known to the CEO or key board members and who seem to be qualified to serve on the board, have an interest in serving on the board. What I see changing — not dramatically, but gradually — is a sense, particularly for [small community banks] that want to become larger, that they need to go outside of their circle of friends to find individuals with skillsets that are needed or attributes that are needed.”

I think an emerging best practice for bank boards is to perform a periodic board needs assessment to determine whether the skills and experience of the bank’s current directors supports its strategic plan, particularly if that plan calls for major changes like expansion into new lending categories or geographies, or a decision to go public. This assessment essentially summarizes the skills and experience of all your directors, grouping them into categories. Smaller banks often find that they are overweighted in certain categories – CPAs and attorneys come to mind – while underweighted in categories like technology, and female and minority directors.

“It’s really a process of who can bring either expertise or business to the bank,” says Donald Musso, president of FinPro, a consulting firm in Gladstone, New Jersey, that often handles director searches for its bank clients. “And I think it’s a combination of the two that we’re seeing people look for.”

Musso cites the example of a client bank in northern New Hampshire. “This organization has been very rural, and two or three of the board members are now living in Florida, and they’ve come to the conclusion that they can’t make it work,” he says. “[These directors] can’t come up in the middle of winter for meetings, and they can’t do the meetings digitally because it’s not the same.” FinPro put together a strategic plan for the bank that calls for it to expand into new markets south of its current location, and Musso will search for new directors in those markets who can not only replace the Florida-based members but help the bank with business development. “We’re looking for people who are really well connected in those marketplaces, who can introduce us to the right business owners and the right political leaders to get quickly accepted,” Musso explains. “We know that folks from northern New Hampshire don’t have any contacts down there.”

Once you know the kind of director you want to fill a vacancy or expand the board, how do you find them? McAlpin says that board chairs (or whoever that task has been delegated to, like the governance committee) often reach out to trusted advisors for suggestions and referrals. “They’ll talk to their attorneys, their accountants, bank consultants they may know … and other bankers,” he says.

McAlpin also suggests that boards actively research their communities for good director candidates. If the chief executive officer or board chair only recruit from within their personal universe of known people, they are by definition restricting the pool of likely candidates.

“What I’ve suggested to people is if you really are looking for skill sets, mount some kind of proactive search within your market,” says McAlpin. “Have someone at the bank do some research on who’s heading up the local manufacturing plant for an automotive manufacturer. Is that a woman? Is that an African American? Who are the people making a splash in the community? So, it’s still word of mouth, but it’s a wider circle of word of mouth. That’s how I’m seeing it work.”

Musso tries to cast a wide net when fishing for board candidates. He agrees with McAlpin that boards should thoroughly research their communities when conducting their own director search. “We don’t use a search firm; we call folks directly,” he says. “So we can look up female CPAs pretty quickly. We can get lists of minority-owned businesses pretty quickly. A lot of that stuff is readily available data from Dun & Bradstreet and other sources.” Musso has found that local accounting firms that handle audits for area businesses are another good referral source. “They’ve been a huge, huge help in finding people and bringing names to the table,” he says.

And when he conducts a search, Musso is often looking for someone who can help the bank accomplish a strategic objective. “We’re constantly seeking spheres of influence,” he explains. “We want to know who is most connected to a given strategic thrust we have in the bank. That’s the ideal person. When we find them, we want to get them on the board as quickly as we can.”

Other recruiting suggestions include financial technology companies, which Musso says offer a pool of potential director candidates who can help banks manage the digital transformation process, as well as former directors who left their boards after their banks were acquired. And while they generally have a different mission, people serving on nonprofit boards are another pool of potential candidates.

These recruiting tips all tend to be reactive in nature; they are things you can do after a vacancy opens up on your board. A more proactive approach would be to establish an advisory board of local business and community leaders to not only advise the bank on important issues, but also to scout them as possible directors for the bank board.

“Particularly if your bank is in multiple geographic locations, just set up some advisory boards,” McAlpin says. “You get local business people together and buy them lunch or dinner. They get the opportunity to interact with each other, and they can talk about their business, and then you learn from them about what it is they think is important to the bank or what the bank can be doing for the community. You also get the opportunity to assess these people in terms of potential future board members.”

While smaller community banks often do their own board recruiting, larger banks often retain an experienced search firm to help them fill board vacancies. “When we’re engaged by a board to conduct a director search, they often are … engaging us to go out and find a very specific level of expertise,” says J. Scott Petty, a Dallas-based partner who leads the financial services practice at the executive recruiting firm Chartwell Partners.  “Or they’re looking for somebody that’s both bringing the expertise we’re looking for and diversity.”

The process from that point on is pretty straightforward, Petty says. He will develop a “position description” based on what the bank is looking for in a prospective candidate. “In that position description, it would be a description of the bank; it would be a description of the qualifications of the background that we’re looking for. And it would also outline if they’re a public bank and their meeting dates for the board.”

Petty says that at the beginning of any engagement, it’s important that he and the board get to know each other. “We would get together face to face to talk about their need and through that process, they would need to get comfortable with me as their ambassador in the marketplace doing the recruiting,” he says. “And that comes by just getting to know me professionally, understanding the experience that I bring to the table, understanding some of the assignments that we’ve worked on before where we’ve had success and then getting to know me a bit personally. Again, they’d have to get comfortable with me representing them and that I understand their culture. And in that process, they would need to see how I feed back the information that I’m receiving from them to give them comfort that I’m the best person to go out and execute this process for them.”

On the Radar For the Pandemic’s Next Phase

The banking industry must address and satisfy several competing interests as executives and the workforce adjust to the new normal of life during a pandemic.

Banks across the nation have stepped up as leaders in the fight against the Covid-19 pandemic. Now as the dust settles from the initial shock in mid-March, what are issues that your bank should be prepared to address looking forward?

When and how should we reopen our physical locations?

While banks have continued operations during the pandemic, many limited their services. It is not clear when these services will fully ramp back up. As your bank debates the best course of action for your circumstance, consider the following:

  • Prioritize health and safety by installing physical protection at branches and offices, including sneeze guards at teller windows, medical screening of employees, enhanced cleaning procedures and required use of personal protective equipment.
  • When considering return-to-work policies, be flexible and responsive to employee concerns and location-specific issues.
  • Apply the lessons learned during this period and embrace (or even improve) the technology for working remotely.
  • Task teams with understanding federal, state and local requirements related to the pandemic and the bank’s corresponding compliance obligations. These teams should meet regularly to ensure full compliance at all locations.

The ABA published a free matrix to assist banks in their reopening efforts.

We participated in the Paycheck Protection Program; now what?

There are some important post-lending matters for banks that participated in the Paycheck Protection Program to consider:

Brace for litigation. Some banks have faced lawsuits from applicants that failed to receive PPP funding. While your bank may not be able to avoid a similar lawsuit, it should avoid liability in these suits by following established procedures and demonstrating that your bankers did not deny applicants on a prohibited basis (race, religion, gender, age, among others).

Additionally, banks have encountered complaints filed by agents of borrowers seeking lender fees. You should not face liability in these suits if you did not execute a binding agreement with an agent before loan origination. Your bank’s defense will be even stronger if you mitigated this issue on the front end —for example by requiring borrowers to certify whether they used an agent, and if so, requiring the agent to complete a Form 159.

Stay current on loan forgiveness requirements. The Small Business Administration stated that it would review all PPP loans over $2 million following each loan forgiveness application submission. Thankfully for lenders, banks can rely on borrower certifications on loan forgiveness amounts. Nevertheless, agencies continue to release new guidance, and customers will rely on lenders to help them through the process.

Look for new opportunities to serve your customers and communities. There are rumors that Congress may issue a third round of PPP funding that will apply to more eligible borrowers. The Federal Reserve announced the expansion of its Main Street Lending Program, which can be a valuable source of liquidity as banks seek to meet customer needs. The SBA also released guidance on the sale of participating interests in PPP loans.

What regulatory or supervisory concerns should we be prepared to address?

Credit Decisions. Your bank must continue to balance meeting customer needs and making prudent credit decisions in the current economic environment. Many banks have started tightening credit standards, but this comes with a potential uptick in complaints about harmful lending practices. Regulators have indicated that they will scrutinize lending activity to ensure banks comply with applicable laws and meet customer needs in a safe and sound manner. The Office of the Comptroller of the Currency urged banks to “prudently document” their PPP lending decisions. The Consumer Financial Protection Bureau instructed small business owners “who believe they were discriminated against based on race, sex, or other protected category” to file complaints. Your decisions on credit parameters must be well thought out and applied uniformly.

Bank Secrecy Act/Anti-Money laundering Focus. Banks may face heightened risks from new customers or new activities from existing customers. For the first time since 2014, the Federal Financial Institutions Examination Council released updates to the Bank Secrecy Act/Anti-Money Laundering (BSA/AML) examination manual. While these updates are not directly related to the pandemic, regulators may scrutinize BSA/AML efforts at your next examination. Use this updated guidance as a springboard to assess your BSA/AML compliance program now.

IT and Security Concerns. Banks used technology enabling virtual or remote interactions during the pandemic, increasing risks associated with IT security. The regulators issued a joint statement addressing security risk management, noting that bank management cannot rely on third-party service providers and must actively ensure technological security. Expect this to be an area of focus at your next examination.