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Five Cs for boards

Effective risk management hinges on boards getting basics right

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  • By  Harold P. Reichwald, Manatt, Phelps & Phillips, LLP
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Bank directors play a key role in enterprise risk management. Bank directors play a key role in enterprise risk management.

In the five years since the onset of the financial crisis, bank regulators have increasingly stressed the importance of enterprise risk management as a way of focusing bank decision-making on the bank’s tolerance for, and management of, risk given its strategic goals. In that effort, bank regulators look to the bank’s board to set the proper tone and culture for effective risk management.

At the same time, the regulators recognize that a key element in this effort is to ensure that the board of directors operates within a framework of strong corporate governance, i.e., that the rules and practices by which the board operates are designed to maximize the bank’s safety and soundness and to minimize the possibility of unforeseen risks arising that could threaten the very existence of the bank or its profitability.

The banking landscape over the last five years is littered with failed banks whose boards were inattentive to these principles; insufficiently engaged or informed of rising risks within the bank; and otherwise seemingly uncaring about the effect of such risks on the safety and soundness of the bank.

Effective board governance at these banks might have enabled them to weather the prolonged downturn that has prevailed in the banking industry over the last five years.

The concept of good corporate governance at the board level often is hard to describe succinctly. But it does depend upon the operation of a series of principles which can be described as the five C’s of board governance:  Competency, Collegiality, Confidentiality, Communication, and Culture.

Looking at the 5 Cs

Let’s examine each:

1. Competency contemplates that each board member have an understanding of the business of banking and the bank’s activities.

It requires that among the board members there is a depth and breadth of relevant experience in a variety of pertinent banking areas as well as competent advisors who are available to the board. It includes the importance of both self-assessment and peer assessment for the board members. And that the board has in place appropriate succession planning taking into account age and retirement considerations.

This principle also covers the importance of board members acting independently and without conflicts of interest.

2. Collegiality stresses the importance of trust among the board members and the encouragement of board members to voice their opinions fully, including expressions of differing points of view.

It encourages respect for all views expressed by individual directors and discourages attempts at private decision-making or influencing management away from the boardroom.

It demands that the board be seen as acting with one voice in making decisions—even when there are dissenting views expressed in deliberations prior to a vote.

3. Confidentiality addresses the need for board discourse to stop at the boardroom doors and for the board discussion to be reflected only in the board minutes.

It means that while disagreement and even discord can and should be tolerated during board meetings, once board members have fully aired their views and votes are taken, there cannot be any second-guessing of those decisions by individual board members after the fact.

Moreover, there must not be any attempts at undercutting of board decisions in private discussions between individual board members and management. Finally, board members should not discuss board decisions with the media, but rather should refer these inquiries to the bank’s appointed representative.

4. Communication covers the flow of information among board members, from board to management and from management to the board and is the basis for a vigorous program of internal controls.

Without the open exchange of ideas to and from the board, the bank as a whole can suffer from a lack of understanding of current goals, strategies, tactics, and policies. Such a failure of information can also prevent the board from appreciating the significance of developments on the ground and taking such steps as may be necessary to remedy identified problems.

Such open communications encourages timely reporting through appropriate channels from all levels in the bank of the occurrence of risk-related events so as to permit the taking of remedial steps and the amendment of existing policies and procedures if necessary.

5. Culture is a set of shared values.

It’s the glue that holds an organization together and motivates employees at all levels to perform at maximum energy for the good of the organization as a whole with minimal mistakes, lapses, or negligence. It contributes to the establishment and effectiveness of internal controls and promotes employee morale. It encourages board member and senior management training in a variety of areas on an ongoing basis.

The board is the bank’s most significant component in establishing risk parameters and policies and procedures in support of those parameters. Board action infuses a sense of culture and cohesion through the appointment and supervision of management whose responsibility it is to carry out those policies, thus confirming the applicable standards for the bank’s overall operations.

Fundementals to build on

Obviously, these 5 Cs are not all of the characteristics of a well-functioning bank board.

But they are a set of principles that must be present, lest the bank inevitability suffer unanticipated losses. This set of principles is not regulatory window dressing to be ignored and paid attention to only when regulatory pressure is applied.

As the banking industry looks to the future with the expectation that the worst of the financial crisis has passed, heightened optimism fuels growth plans, particularly through mergers and acquisitions. Thus, the principles of effective bank board governance are never more pertinent than in the challenges faced by a board immediately after a merger or an acquisition as the board struggles with integrating two organizations and melding two possibly different cultures.

Adherence to these principles provides the pathway to success.

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