Informed, independent governance is critical for banks

Jeff Campbell, Eide Bailly

From a regulatory perspective, the expectations placed on boards of directors have changed tremendously over the years. In response to the banking crisis, Congress included provisions within the Dodd-Frank Act of 2010 that gave more responsibilities to directors for regulatory compliance and risk management functions while also increasing fiduciary liabilities.

When the Federal Reserve placed strict limits on Wells Fargo’s growth in response to its sales practice abuses, the Fed laid blame at the feet of the board for accepting management assurances that the bank was conducting effective monitoring. “The board should have received more detailed and concrete plans from senior management on such a critical issue,” said the Fed’s Michael Gibson in a letter sent to the Wells Fargo board.

“Regulation tends to be reactive,” said Jeff Campbell, a senior bank consultant at Eide Bailly. Governance directives born out of crises or headline news tend toward the “one-size-fits-all” model, Campbell explained. Governance responsibilities still do depend upon the size, location, complexity, and risk profile of a bank.

Although definitions of corporate governance vary, the focus oftentimes is on relationships, policies and processes that provide strategic direction and controls for an organization. Eide Bailly, in its literature on corporate governance, writes: “Banks should have a governance structure designed to provide for safe and sound operations, as well as a framework to remain profitable and resilient through challenging economic and market conditions.”

The case for the outside director
Bank size certainly affects board frameworks, says Campbell, who until 2011 owned the $63 million Security State Bank of Dunseith, N.D., a closely-held bank. At some banks, he said, the board is comprised of all family members, whether or not they are involved in day-to-day management. “Those situations create different dynamics,” Campbell said.

Regulators have expressed concern for years that closely-held banks need outside directors. “The idea is you get different perspectives,” he said. “Maybe that outside director is involved in, seeing or hearing about how the bank is perceived in the community. They can provide that insight, which can be helpful in steering the bank toward a better path.”

Other benefits to inviting participation of outside directors can be to fill gaps or weaknesses in the board, or to gain inroads into new markets. Banks looking to lend into new sectors, for instance, will want to look around for someone in that industry who could serve them well as they try to grow that sector. “It’s really about looking at the strategic plan of the bank,” Campbell said. In looking at a new industry, banks should ask themselves if they have someone at the board level who can help them represent that industry.

Commercial real estate is one such sector, Campbell said, where it can be extremely helpful to have someone on the board with that type of expertise.

Effectiveness is critical
History shows that bank directors who establish and maintain a strong foundation in operational oversight provide critical insight in supervisory efforts. This sends a clear message to staff that the board values a strong risk management culture.

A challenge for board members and senior management lies in finding ways to work collectively while maintaining board member independence. Bank directors are responsible for overseeing the conduct of the bank’s business using independent judgement. That requires board members to appropriately challenge senior management opinions, recommendations and assessments when appropriate.

Not having that ability or expectation, but routinely deferring to management’s decisions without exercising their own informed judgements, is an indication that a director is not adequately serving his or her institution, its owners or the community. This can open the bank to increased regulatory scrutiny. Directors have a responsibility to ensure their voices are heard.

The ability to critically self-assess is another way directors can measure performance. There are a variety of methods to conduct assessments, Campbell says. “The tools we often see will ask the manager how he or she thinks the staff perceives them in their role.”

Training is another metric that turns up in assessments. Campbell said he envisions an assessment question that asks a president/CEO how he or she is training people to build “bench strength” in terms of succession planning.

“In a self-assessment, the tendency is to not think about things as someone might if they were assessing someone else,” Campbell said. “At the board level, general board effectiveness assessments are something the board might do collectively.”

To pursue a different perspective on board or management effectiveness, Campbell suggested a peer-to-peer assessment. An alternative is to hire a third party to come into the bank to provide a report on board effectiveness.

Director training
When Campbell sold his bank, the acquiring institution required its directors to get 20 hours of training per year.

“We’ve seen a lot of growth in director training,” Campbell said. All of the regulatory agencies offer some form of training. Campbell cited, a service provided by the Fed as the premier source. State and national banking organizations offer director training programs as well. These are sometimes built around the topics that are important in the current climate, things important to the industry today, from a regulatory perspective. While compliance is an ongoing dynamic, Campbell said, issues that are exploding are vendor management and the whole gamut of risk management. Training programs offered to the directors according to their schedule is important.

Campbell said the key to successful director training is that it is conducted professionally and is consistent. “We want every board member to hear the same message.”
The days when a bank board meets to approve expense checks or loans or policies are over. Today’s directors are expected to keep themselves informed of the activities and condition of the bank. Ongoing education and staying abreast of industry trends and regulatory developments are expected.

By putting in place a corporate governance framework, banks help directors navigate their way to being a valuable member of a bank’s board.

Directors have primary duties of loyalty and care to their institutions. Good banks don’t just want strategic, proactive directors, Campbell said. “They already have them.”

Jeff Campbell and Darrell Lingle of Eide Bailly assisted with this article.