When industry image ebbs, it's time to improve bank governance

The public’s perception of banking is arguably more negative today than in years past. A recent Harris Poll asking how well certain industries serve their customers revealed that almost 40% felt that banks do a bad job. No doubt the bailouts of some of the largest financial institutions last year, and the number of bank closings this year, contributed to this negative view.  

One of the best ways to combat this overall negative image and to make sound decisions is by implementing good corporate governance practices. Board members have a  “duty of care,” to exercise the same level of care in making decisions for the bank that an ordinary person would use in making his or her own personal or business decisions. This means that board members are expected to attend the board meetings, actively participate in those meetings by asking questions, be informed about what is being discussed, and exercise independent judgment. Good corporate governance practices can help board members fulfill their duty of care, as well as help them make sound decisions, which hopefully will keep the bank off the front page of the morning’s newspapers and off of your favorite website.
 
Corporate governance has evolved in the wake of the 2002 passage of the Sarbanes-Oxley Act.  As a result, there are many corporate governance requirements for public companies that serve as best practices for private companies, including banks.
 
Here are seven suggestions to improve the corporate governance practices at your bank.

1. Select an outside chairman of the board.
More and more boards are going to an outside chairman, who is neither a bank officer nor related to the bank CEO. Having an outside chairman can prevent the board from being dominated by one person, and provides an atmosphere for input by all board members.

2. Distribute board packets in advance.
Banks have various means of providing information to their board members, ranging from requiring the board members to come into the bank to review the board packets, to emailing the board packet to them well in advance of the meeting. Prior to emailing the board packets, an analysis of the security of email should be made, as well as the sensitivity of the board information. Rather than email the board packets, some banks make them available by having board members log on to a secure portion of the bank’s website and review or print the packets.
 
While there is no one right way to provide information to the board prior to the meetings, board packets should never be handed out at the board meetings. This does not allow them any time for reading the information, formulating an opinion, and being prepared for appropriate discussion at the board meeting. In order for the directors to fulfill their duty of care, they need to be prepared for the board meetings. This means they need to read the board packet prior to the board meeting. Ideally, the board packet should be sent to the board members a week prior to the board meeting.

3. Review board packets for relevance, and trim where you can.
Many board packets contain the same information that they did 25 years ago. As regulators have required directors to review more and more information over the years, board packets have grown to contain this information. But rarely is anything deleted. Thus packets in many banks have become unwieldy and filled with distracting and unnecessary information.
 
Now is a good time for a thoughtful and objective review of the board packets to ensure that the information provided to directors is relevant and necessary considering the size and condition of the bank. For example, directors might still be reviewing each overdraft on a given date as the board did when the bank was $25 million in assets. But now that the bank is $250 million in assets, it might be time to streamline this report to just the large overdrafts. Another example is where a board reviews each loan made in a given month, where the report could be streamlined to reflect only those loans over a certain threshold dollar amount.
 
When packets contain so much information of lesser importance, directors grow distracted from  focusing on the most important issues. Certain core information should be presented in a manner that is concise and gives directors the information they need to supervise the bank in a professional manner.

4. Hold executive sessions at each meeting.
Public companies are required to have executive sessions of the board without management. This is a best practice that should be extended to private companies. An executive session at each board meeting can serve as a tonic for the non-management board members, as well as the bank executives, even if the executive sessions only last a few minutes. Such sessions provide a forum for frank discussion of issues without management present and allows the independent members an opportunity to obtain the views of others without the influence of bank executives. An additional benefit: Bank executives won’t feel panicked because an executive session is taking place if it occurs at every board meeting.

5. Review audit committee composition.
Public companies are required to place all independent board members on the Audit Committee, with a Committee Chairman who is considered a financial expert. This would be someone such as a CPA or someone otherwise qualified to read and understand financial statements. This is a best practice that should be extended to private companies. While there are specific rules regarding how independence is established, generally Audit Committee members should not be bank officers or related to bank officers.

6. Review composition and size of the board.
Many bank board members have served together for years, with no recent changes. Some boards contain many members of one family, perhaps all related to the bank’s CEO. Some boards consist of only five directors. A review of the composition and size of the board may be in order.
 
Public companies are required to have a majority of directors who are  “independent.” The definition of  “independence” is quite complex, but generally means that if a director is not an officer or employee of the bank, or is not related in some way to bank employees, or has not been employed by the bank for the past three years, he or she is considered “independent.” This is a best practice that should be extended to private companies. The addition of board members to attain a majority of independent directors will add a new dimension to the decision-making process of the board.
 
A certain number of board committees are necessary for the proper supervision of the bank. Most banks have six or more committees, such as Loan, Audit, Asset/Liability, Trust, Governance/Nominating, and Compensation. Small boards have difficulty adequately manning all these committees, with directors carrying the burden of sitting on numerous committees. Expansion of these boards to nine or eleven members may be in order so that the directors have the time to contribute in a meaningful way to the supervision of the bank.
 
The collective expertise of a board should also be evaluated to determine whether additional expertise needs to be added. For example, does the board possess banking expertise? Although a requirement for boards of newly chartered banks, this is not imposed on existing banks, but perhaps should be.

7. Hold board member training.
Many banks have never provided any training to their board members. Training is important to assist them in fulfilling their duties and responsibilities and to give them a basis from which to make sound decisions. However, training is especially critical for new board members, especially for those who are not familiar with general corporate governance, much less the banking industry with all of its many complex regulations and requirements. New member board training should consist of an orientation session, as well as a training session geared specifically to new bank directors. Refresher courses for seasoned directors should be tailored to understanding the bank’s business model, problems in the bank, as well as changes in the regulatory environment.
 
These seven suggestions are just some of the things that the board can do to improve the corporate governance practices in the bank, to assist them in making sound business decisions, and to help keep the bank, and the bank’s reputation, whole.