Banking and NBFI governance in the new economy beyond crisis

The banking sector has successfully navigated the immediate pressures of the COVID-19 crisis. As thoughts turn to a new world beyond the immediate crisis, a strong financial sector will be needed for a strong recovery. 

In a low interest rate, low profitability world, where the risk of the pandemic still remains, financial institutions will need to focus on better governance, capabilities, customer needs, while driving efficiency and building resilience. 
On the other hand, a bank or NBFI Board’s key duty is to create and deliver sustainable shareholder value through setting strategy and overseeing its implementation. In doing so, a board needs to give due regard to matters that will affect the future of the bank or NBFI, such as the effect the board’s decisions may have on employees, the environment, communities and relationships with suppliers. 

The board must also ensure the management team achieves the right balance between promoting long-term growth and delivering short-term objectives. Members of the board are also responsible for maintaining an effective system of internal control that provides assurance of efficient operations and for ensuring that the top management team maintains an effective risk management and oversight process across the company. 

Today, the financial sector is constantly being buffeted by waves of economic and political shocks, capital issues, talent migration, regulatory and technological challenges. The increased regulatory burden and related costs impact every financial institution in both the approach to doing business and the expense of doing business.

Better governance
The financial industry is now in transition, with many challenges ahead. As a result, there has never been a greater need for well-functioning, ring fenced, informed and upright boards of directors. 

There has also never been such a more important time for board members to keep in mind that their responsibilities go beyond the institution they serve. 

To achieve long-term value for shareholders bank boards would need to look for ways to strengthen their institutions and to do this they need to strengthen themselves as a board. One way of doing that is to adopt the practices of effective boards – getting competent and credible directors to their boards. 

Well performing companies on many occasions have been destroyed by bad governance and shareholder interference. That is what the Enrons, the Worldcoms, the Satyams and all the scam tainted companies like GK and CIFL are all about. 

Almost always it is the board and the top management of these companies that set these firms on the path to rapid decline. These are classic examples of boardroom and top management failure in discharging their fiduciary responsibility to depositors, creditors, employees and shareholders and their failure to ensure the long-term health of the institution.

 Most legislative and regulatory action by most governments’ post 2008 was geared towards preventing such episodes in the future. The regulators so far have done a commendable job under very difficult conditions. 

Director criteria
The most challenging and distracting issues a board can face are those related to its own members. These issues typically arise in connection with conflicts of interest between board members and the institutions they serve, or when board members experience financial difficulties of their own. 

A board can also lose its effectiveness when there are personality clashes in the boardroom or when one or more board members seek to dominate the deliberations. The best time to avoid such issues is during the selection process for new directors. Compromise in the selection of directors will almost always dilute the effectiveness of the board as a whole.

Directors add value to a bank and NBFI board when they:

• Have a good level of financial acumen
• Track record of credible behaviour.
• are aware of risk fundamentals and techniques
• are able to manage dynamics with top executives
• Demonstrate emotional intelligence, when addressing tough issues

To play that role; directors need to have the following key characteristics:

• Independence and care about the progress of the institution deeply – being free of conflicts.
• Time to devote to the job – to prepare for board meetings and to participate in committees.
• Be competent and demonstrate integrity – being fully engaged, credible and proactive as a board member.
• Courageous and Resilient – ability to deal with tough issues.
• Willingness to learn.

A group of good, solid and dependable board members could be far more effective than an all-star line-up of directors. A board is far more effective when it acts as a group of equals, where all members can voice their opinions, and where difficult questions can be asked. 

Dominant shareholders and board cultures in which constructive debate never occurs have contributed to the demise of many financial institutions. Therefore careful selection of new board members, keeping in mind the strengths and weaknesses of the other members of the board, is well worth the time and effort involved. 

The board of a financial institution that runs on public deposits is accountable as a group, since their functioning is essentially collegial in nature, and is expected to promote a shared point of view about what decisions the firm should make to create lasting value.

Board composition
The composition of a board, and the interpersonal dynamics among its members are critical for the success of a financial institution. A bank board, like any other working group can be heavily influenced by members who dominate the conversation, or by members who actively discourage discussion or dissent. 

A board is not intended to merely rubber stamp the proposals of management. If the responsibilities are to be effectively discharged, it is important that the composition of a board, and the interpersonal dynamics among its members are right. 

While integrity is an essential prerequisite, this alone is not sufficient. 

Directors must be people who are alert and have the capacity to understand the inherent risks taken on by an institution and objectively analyze the proposals submitted by management on various aspects of a firm’s operational challenges. However, it is equally important that the board has competence within it which embraces other disciplines such as law, economics, marketing, human resource management and Information Technology, so that a multidisciplinary approach is taken to managing risks, growing the bank business and protecting public deposits .

Meaning of Independent directors
Most codes now insist that one-third of the numbers of directors are independent non-executive directors. However, independence is not about ‘no-shareholding’, and it is more about how independent the director is in his thinking beyond and his ability to challenge proposals at the board meeting. 

Non-executive directors are the ones who really should perform the real role of independent directors, since executive directors are often left to defend decisions and proposals in Board meetings. Also, every code now requires nomination committees to recommend the appointment of new directors. 

The main purpose of having a nomination committee is to ensure that there is a transparent appointment process, which is not under the control of the shareholders, chairman or the CEO, and to ensure that the right balance of skills, experience and independence is brought to the board table, while giving due consideration to shareholder, market demands and headline institutional requirements.

Education and development
Most directors only visit the institution they represent once or twice a month, which makes a full understanding of the operations very challenging. Also, given the limited scope of the role most directors don’t understand the business well enough to challenge the executives. Therefore there certainly needs to be an educational element brought into board meetings and beyond to ensure the directors properly understand the business they are overseeing and also have the competence to get under the skin of the institution and follow up on things that don’t seem quite right. Most directors are expected to focus on continuous professional development to ensure they stay ahead of the game. 

With such education, directors can become far more effective in identifying and understanding of the risks to be managed, as well as the key drivers that most influence a bank’s performance. This also means having  the gender balance, getting people on the board who are experts in things like branding, HR, learning, and the like—not usually the kind of people boards look to right now. That is why most boards fail to notice major risks that they should have caught in the first place. 

Future
Board members are now expected to provide oversight and perspective to the executives running the institution by bring their own experiences from other institutions they have managed to the table to help the institution to make better quality decisions and to help build a sustainable banking business. 

Globally, banks especially after the pandemic are experiencing a growing tension between supporting their customers, governments and increased concerns about the rise in non-performing loans (NPL), which will lead to capital depletion. 

While joint action with governments and regulators are required to address the immediate NPL overhang, the repercussions for businesses and individuals are expected to be longer lasting. Looking ahead, there are four areas of focus that will reshape the Banking sector and support a stronger recovery: employee development; serving customers better, through the right channels, with relevant products and services; adapting to new ways of working; and building more resilient and agile and bigger banks. If Boards fail to facilitate this, they will face the wrath of the depositors and employees and even face legal action and be backlisted as professionals.
(The writer is a Thought Leader)