UDC Friends-Le Blog des Amis de l'UDC en Romandie

By Paul Myners, Former member of the Financial Reporting Council
Source: Financial Times

Proposals to overhaul the banking system have largely ignored the governance of our banks. But if other reforms are to have any traction, it is essential to shake up the boardrooms that oversee the rest of the operation.

First, board members should never forget that the most vital part of their job is to challenge executives. My rule of thumb is swiped from Voltaire: judge a person by his or her questions. Are board members asking the right questions and with enough persistence? Simple in theory, but not easy to do in environments where anything more than the occasional mundane query is regarded as bad form. I have had meetings in the boardrooms of nearly all our big banks. Some are stuffy and some are modern, but none of them feels like a room made for serious discussion, decision-making or curiosity about the source of profits and profitability or the location and scale of risk.

The typical bank board resembles a retirement home for the great and the good: there are retired titans of industry, ousted politicians and the occasional member of the voluntary sector. If such a selection – more likely to be found in Debrett’s Peerage than the City pages – was ever good enough, it is not now. The business of banking is exponentially more complicated than a generation ago, and the panel guiding it must be able to follow its dealings. At the very least the chairman and senior independent director or chairman of the risk committee should have recent and relevant banking experience. Most do not. Few non-executives have the skill or appetite to challenge the thinking behind risk budgeting; to identify weaknesses in risk measurement techniques or the spurious accuracy implied; to reach their own view on asset and liability valuations or reach a view on capitalisation independent from the minimum levels required by regulators and suppliers of credit.

Bankers’ pay is an area where independent directors on remuneration committees can have a big influence. It is their job to ensure that compensation aligns with the interests of shareholders. Yet given the explosion in financiers’ bonuses it is doubtful whether banks’ independent directors were sufficiently challenging about incentive effects or sensitive to the culture they were promoting. Since excessive pay often drives goofy corporate strategy, and vice versa, such a relaxed attitude has been doubly harmful.

Finally, all the talk about increased powers for regulators should take into account who those officials deal with. Regulators will typically bring concerns about risk to executives. It would be far more effective if they were also to engage with outside directors. The warnings about underpriced and undermeasured risk, particularly from the Bank of England, did not get through to the non-executive directors who had the obligation and power to challenge reckless pro-cyclical policies.

Unless there is a change in the way banks are governed, the excesses that led to the credit crunch stand to be repeated. It is not surprising that the Bank’s governor said this week’s bail-out was “not to protect the banks but to protect the public from banks”. Bank boards and their non-executives in particular, who played the main role in allowing this crisis to happen, are going to have to raise their game.