How can bank boards respond to increased regulatory scrutiny?

Bank directors have always played a critical role in ensuring the success of their institution. Unfortunately, the recent economic crisis highlighted shortcomings in boards’ understanding of risks and the proper oversight of those risks. This may have been due to some directors lacking experience and/or being too closely tied to the bank.

A recent Wall Street Journal article by Victoria McGrane and Jon Hilsenrath highlighted how the nation’s regulators are increasingly questioning and turning their focus toward bank boards. While the larger banks are receiving the bulk of attention, boards at smaller, community banks are realizing that they’re not immune to this heightened attention. These smaller banks have also seen new, and more frequent, attention from regulators.

The article stated that while supervisors have always interacted with bank boards, industry experts have noticed a “new level of scrutiny over the past two years.” McGrane and Hilsenrath also noted that following the push for higher capital cushions, “regulators are now focusing on corporate governance and the role of directors to ensure banks have the right culture and controls to prevent excessive risk taking.” Meetings between regulators and directors have increased, sometimes happening more frequently than the board itself meets.

As noted in the OCC’s document, Common Sense Approach to Community Banking, a bank’s board of directors “must determine whether the risks the bank assumes are warranted, effectively managed, and consistent with safe and sound banking practices.” The key is to find the right balance between proper and necessary oversight and taking on too much responsibility (such as taking on responsibility that should be delegated to senior management).

Lynn McKenzie and Edmund Green of KMPG recently contributed an article to Bank Director on how boards can challenge their banks’ management on risk. They said that as the risk environment evolves, “directors can benefit from risk management training focused on the board’s role in ensuring the adequacy and effectiveness of the bank’s risk management functions and activities.” But this should be viewed as an ongoing process rather than just a one-time occurrence – it must become “embedded in the way management runs the bank and the board conducts its stewardship and oversight responsibilities.”
McKenzie and Green provided three areas that bank board members should consider:

1. If the bank isn’t required to maintain a risk committee (under $10 billion in assets), is there an appropriate degree of focus and attention on risk management?
2. How complex is the bank’s operating model? What is the pace of change in the organization and markets served? What about liquidity risks, interest rate exposure and IT security threats?
3. How is the management of risk overseen? Audit committee? Multiple committees? The full board?

Either way, McKenzie and Green said the entire board is responsible for “understanding the bank’s key risks and credibly challenging management’s assessment and response to those risks.”

Their article also highlighted eight considerations bank directors can use to help evaluate their risk oversight. One important consideration is the use of a formal risk appetite statement or document. At a Sageworks ALLL Executive Seminar in Boston in 2013, Jay Gallo, former partner at RMPI Consulting and current CRO at Sage Bank in Lowell, MA, defined a risk appetite document as one that provides a “consistent framework for understanding risk through the organization and means to ensure that risk considerations are ingrained in the day-to-day operation of the firm.” This document is a great starting point for banks looking to more properly define their risk framework.

While a lot of the pressure seems to be on bank boards, senior management is not absent of regulatory responsibility. They should be accountable for providing the necessary information to boards and in a clear and concise manner. This is especially true when it comes to presenting stress test results to the board, as the area has received increased attention and scrutiny as of late.

For tips on how to provide stress test results to the board, download this whitepaper, Stress Testing: Presenting Results to Your Board.