The Dodd-Frank Act was undoubtedly a thorough re-working of the regulatory paradigm for banks and other financial institutions. But no less resolute are the intentions of U.S. banking regulators to carry regulatory reform further, based in significant part on perceived “macroprudential” authority after Dodd-Frank. The new regulatory paradigm will increasingly leave behind bank regulation’s traditional moorings in the protection of federally insured deposits and safe and sound operation of banking organizations. Instead, “macroprudential” regulation will rest on the goals of protecting U.S. financial stability and reducing systemic risk—broad, malleable concepts that elude precise definition. It will seek to influence activities not just of banking organizations but also activities conducted by non-bank entities not traditionally subject to prudential regulation. And, according to an important speech given last week by Federal Reserve Governor Daniel K. Tarullo, the new regulatory paradigm embraces consideration of a potentially unprecedented expansion of the fiduciary duties of directors of banking institutions. This would give such directors very potent incentives to prioritize supervisory goals—including macroprudential objectives.
Posts Tagged ‘Bank boards’
Like in the US, European policy-makers have taken a number of measures as a reaction to the financial crisis, some of which address corporate governance issues of credit institutions and investment firms (hereafter collectively referred to as “banks”). Other than in the U.S., however, and more consistently with the financial origins of the crisis, very little has made its way into legislation that applies to non-financial corporations.
2013 was a year of continuing challenges and opportunities for U.S. banks. The low-interest rate environment continued to challenge the ability of banks to lend profitably. Already burdensome regulatory demands grew weightier with expanded Dodd-Frank stress testing and the finalization of the Volcker Rule, among other things. More than ever before, the responsibility of directors of financial institutions for regulatory compliance and bank safety and soundness is broadening, highlighted most recently by the OCC’s steps to formalize its program of supervisory “heightened expectations” for larger banks and their directors. Against this backdrop, the banking industry saw steady and creative deal activity, with a pronounced concentration among community banks.
Banks clearly appear to have different governance structures than non-financial firms. The question is whether these governance structures are ineffective and whether implementing independence standards imposed by Dodd-Frank, SOX and the major stock exchanges will improve bank governance. In our paper, Bank Board Structure and Performance: Evidence for Large Bank Holding Companies, which was recently made publicly available on SSRN, we try to provide an answer to this question by examining the relationship between board composition and size and bank performance. We focus on large, publicly traded bank holding companies (BHCs) in the U.S., which are the banks that are mentioned most often in the context of the crisis.
We first examine the relationship between board composition and size and performance in a sample of data on 35 BHCs from 1986-1999. We deliberately focused on a relatively small number of BHCs over a longer period of time to ensure that there would be sufficient variation in governance variables which typically do not change much over time. In addition, we collected detailed data on variables that have received attention in the law, economics, and organization literature and which are recognized to be correlated with sound corporate governance, but that are generally not studied as a group due to high data collection costs.
In the paper Corporate Governance Structure and Mergers, which was recently made publicly available on SSRN, we examine the balance of control between top-tier managers and shareholders using data from bank mergers over the period 1990-2004. Several studies have investigated the role of independent outside directors at nonfinancial firms. Independent boards (with more than 50 percent outside directors) have been reported in the corporate finance literature to be associated with larger shareholder gains and more effective monitoring of management. Unlike the corporate finance literature on nonfinancial firms, the role of independent outside directors in banking firms has not received much attention in the literature. The role of independent outside directors in banking firms could be very different from those of nonfinancial firms due to banking regulations and supervision (at the state and federal level), deposit insurance, and too-big-to-fail implications for very large banks.
In the paper, Subprime Crisis and Board (In-)Competence: Private vs. Public Banks in Germany, which was recently made publicly available on SSRN, we examine evidence for a systematic underperformance of Germany’s state-owned banks in the current financial crisis and study if the bank losses can be traced to the quality of bank governance.
For this purpose, we examine the biographical background of 593 supervisory board members in the 29 largest banks and find a pronounced difference in the finance and management experience of board representatives across private and state-owned banks. Measures of “boardroom competence” are then related directly to the magnitude of bank losses in the recent financial crisis. Our data confirms that supervisory board (in-)competence in finance is related to losses in the financial crisis.
In our paper, Boards of Banks, which was recently made publicly available on SSRN, we assemble the most complete data set on boards of banks to date. Our data allow us to draw a detailed picture of bank board composition up to and including the crisis period. The data reveal a number of new empirical facts. Right before the beginning of the crisis in 2007, the average board independence in the world’s largest banks was roughly 67%, meaning that two out of three bank directors were formally independent. These high levels of independence are both a recent and mostly North-American phenomenon. In 2000, the average level of board independence in our sample was just 40%. Canada and the US have the highest levels of bank board independence in the world, at about 75%.
Our data also reveal many interesting patterns. Client-directors are usually reported as being independent, although they have clear business relations with the banks that they are supposed to monitor. While the governance literature has focused on the role of bankers on boards of nonfinancial firms, the other side of the coin – nonfinancial corporate clients on boards of banks – has yet to be analyzed.
On July 16 the Walker review of corporate governance of UK banks and other financial institutions (BOFIs) released a consultation paper on the future of corporate governance in the UK financial services sector (the Review).
We have recommended substantial changes to the way the boards of BOFIs function in particular through boosting the role of non-executives in the risk and remuneration process.
We recommend strengthening bank boards, making rigorous challenge in the boardroom a key ingredient in decisions on risk and measures to encourage institutional shareholders to play a more active role as engaged owners of BOFIs.
Sir David said “These proposals are designed to improve the professionalism and diligence of bank boards, increasing the importance of challenge in the board environment. If this means that boards operate in a somewhat less collegial way than in the past, that will be a small price to pay for better governance.”
Five key themes of the Review are as follows:
First, the Combined Code of the Financial Reporting Council (FRC) remains fit for purpose. Combined with tougher capital and liquidity requirements and a tougher regulatory stance on the part of the Financial Services Authority (FSA), the “comply or explain” approach to guidance and provisions under the Combined Code provides the surest route to better corporate governance practice in BOFIs. The relevant guidance and provisions require amplification and better observance but there are no proposals for new primary legislation.
Second, principal deficiencies in BOFI boards related much more to patterns of behaviour than to organisation. The right sequence in board discussion on major issues should be presentation by the executive, a disciplined process of challenge, decision on the policy or strategy to be adopted and then full empowerment of the executive to implement. The essential challenge step in the sequence was missed in some board situations and must be unequivocally embedded in future. The most critical need is for an environment in which effective challenge of the executive is expected and achieved in the boardroom before decisions are taken on major risk and strategic issues. For this to be achieved will require close attention to board composition to ensure the right mix of both financial industry capability and critical perspective from high-level experience in other major business. It will also require a materially increased time commitment from non-executive directors (NEDs), from whom a combination of financial industry experience and independence of mind will be much more relevant than a combination of lesser experience and formal independence. In all of this, the role of the chairman is paramount, calling for both exceptional board leadership skills and ability to get confidently and competently to grips with major strategic issues. With so substantial an expectation and obligation, the chairman’s role will involve a priority of commitment that will leave little time for other business activity.