Corporate Governance and the Board of Directors At Your Bank

August 1, 2020 | Article

By Darrell Lingle and Jeff Campbell

Many organizations utilize corporate governance to help manage and direct their company. Today’s bank directors can benefit from the corporate governance lessons and experiences of others as industry conditions and challenges evolve.

What is Corporate Governance?
Although definitions of corporate governance vary, the focus often is on relationships, policies and processes that provide strategic direction and controls for an organization. The structure is designed to provide for safe and sound operations, as well as a framework to remain profitable and resilient through challenging economic and market conditions.

It’s important to recognize that there is no one-size-fits-all approach to corporate governance. A key element in developing a corporate governance structure is making sure it is appropriate for the size, complexity and risk profile of the bank.

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Who is Part of a Corporate Governance Structure in a Bank?
Board members and senior management are key to the overall success of the bank. The challenge can be in finding ways to work collectively while maintaining independence.

The board and individual directors should establish and maintain their independence. A bank director is 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 their institutions, their stockholders or their communities. The results can put the bank on a path to increased regulatory scrutiny.

The time to discuss and develop a succession plan specific to the transitioning of a community banks board of directors isn’t when facing regulatory scrutiny or when the bank may be financially underperforming.

Researching, identifying and developing a meaningful board succession plan should take place as part of the ongoing strategic objectives of the bank. Good board succession planning rarely just happens. That process allows for discussion about leadership development without any apprehension on the part of those involved. It is a product of the board’s collective commitment to thoughtful planning and a willingness to hold themselves accountable.

How Do You Choose Who to Serve as a Bank Director?
Some areas to consider discussing with a potential candidate are:

Bank Profile

  • Publicly available information of the bank
  • Nonpublic information, subject to constraints of federal and state law
  • Institutional value to the shareholders, employees and the community

Director Profile

  • How the candidate’s background and talents align with the bank’s needs
  • How that knowledge and talent will add value to the board

Benefits of Service

  • Give back to the community
  • Continue to build upon existing skills and knowledge
  • Stay abreast of local and national issues

Assurances

  • Transparency in all aspects of the bank’s operations
  • Timely and sufficient information
  • Appropriate training and educational opportunities
  • Respect for their time
  • Appropriate compensation and benefits, including liability insurance

There is no single profile of the perfect director. All good directors share certain characteristics. According to the OCC’s “Director’s Book,” the principal qualities of an effective director are strength of character, an inquiring and independent mind, practical wisdom and sound judgement. With those characteristics in mind, identifying individuals who provide business skills that otherwise don’t exist on the board will also help the bank achieve its goals.

Over the past several years, many community banks have also been looking for directors who may also better represent a more diverse customer base. That diversification has been primarily thought of along racial, occupational or geographical lines. More recently, that search has started to include another area of diversification age. Although there is no replacement for tenured, experienced and knowledgeable directors, banks may want to consider adding Generation X and Millennial-aged individuals to its board to better reflect and complement its changing customer base.

How Does your Bank Director Work with the Audit Committee?
The most effective audit committees are not only critically aware of their responsibilities, but also completely understand and embrace them—and recognize what is necessary to fulfill them effectively. The work of the audit committee continues to evolve to meet the governance needs as a result of business and banking changes.

Effective corporate governance depends on the active and collaborative participation of all its principle champions—the audit committee, board of directors, independent external auditors, internal auditors and management.

Ensuring that this collaboration occurs economically, efficiently and effectively is fundamental to an audit committee’s success. Its functions and responsibilities, which are approved by the board of directors, vary from institution to institution, but each audit committee’s key responsibilities are essentially the same.

In general, audit committees should assume the following responsibilities:

  • Understand management’s responsibilities and representations
  • Understand and assess the appropriateness of management’s selection of accounting principles and the most critical accounting policies
  • Understand management’s judgments and accounting estimates applied in financial reporting
  • Understand the communications received from the external auditors concerning their responsibilities under generally accepted auditing standards
  • Confer with both management and the external auditors about the financial statements
  • Assess whether financial statements are complete and fairly presented, in all material respects, the financial position of the institution and that disclosures are clear and transparent
  • Review financial statements and other information presented with financial statements prior to approval
  • Pre-approve all allowable non-audit consulting services performed by the external auditor

Best practices in corporate governance recommend that the audit committee’s oversight role be extended beyond the financial statements and related information to include, where practicable, the review of other statements containing financial information and requiring board approval.

Working with External Auditors
The audit committee needs to assure itself that the external auditors are satisfied that the accounting estimates and judgments made by management, and that management’s selection of accounting principles, reflect an appropriate interpretation of U.S. generally accepted accounting principles.

The appropriateness—including the degree to which management bias, if any, is evident—of the institution’s accounting principles and underlying estimates, and the transparency of the financial disclosures in reflecting financial performance, would be at the core of discussion between the audit committee and the external auditor. The audit committee should be interested in discussing and understanding the external auditor’s views on accounting issues and should actively seek to develop a relationship with the external auditor that allows a full, frank and timely discussion of all material issues.

Internal Audit Responsibilities
In addition to the external audit process, the audit committee also oversees the institution’s internal audit process. The audit committee should ensure that the institution’s internal audit function is conducted in accordance with the standards of the Institute of Internal Auditors, and that a regular review is undertaken of internal audit’s performance. The audit committee should attempt to ensure the external audit and internal audit complement each other and that their efforts are coordinated and effective.

How Can Bank Directors Build Out Corporate Governance?
History shows that bank directors who established and maintained strong foundations built from the top down in oversight of the bank’s operations provided critical insight in supervisory efforts. This sends a clear message from the bank’s board to the staff that the board values a strong risk management culture that includes a strong ethical culture, i.e., that the interests of the customers, investors and community take precedence over short-term profits. Trust and public confidence are at the center of a bank’s success. Without them, the ability to attract depositors and investors can be challenging.

As with any successful organization, the ability to critically self-assess plays a valuable role in rating bank management, including the performance of the board of directors.

These “report cards” will help answer questions that address relationships amongst board members, the need for additional training, contributions of individual board members, skills and competency of board members and the need for changes to board committees, along with any number of other areas that specifically measure performance of both individual board members and the functional value of the board as a whole.

The Importance of Corporate Governance in your Bank
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. Putting a corporate governance framework in place will help members navigate their way to being a valuable member of the bank’s board of directors.


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