Financial Services Spotlight

Proposed Fed Guidance for Bank Boards of Directors

Posted by Roy Andersen on Aug 7, 2017 10:05:29 AM

Yesterday the Fed published a proposed guidance document for its expectations for board of directors of banks. The release only applies to the boards of banks with over $50 billion in consolidated assets, but the intent of the Fed is to ease up on directors at all banks. The proposal was issued after an extensive review of the activities of bank boards and reflects independent directors’ dissatisfaction with the burdens that the regulators have been placing on bank directors.

The Fed is going to continue to review the expected role of bank directors and is seemingly moving in the direction of placing the primary burdens of management on bank officers—where it has historically been.

Distinctions between the Roles of Management and Directors

In their review of bank boards, the Fed learned that directors have trouble understanding clearly how their roles and the roles of management differ. The Fed review reveals that directors spend undue time on activities that do not relate to core board responsibilities.  Directors also suffer from information overload, especially at large banks. 

What the Fed is Proposing for Advising Bank Directors

In this release, the Fed is issuing guidance for banks with over $50 billion in consolidated assets. As discussed below, the Fed has identified five key attributes of effective boards of directors that the Board would use when assessing a firm’s board of directors. The proposed guidance would be used in connection with the supervisory assessment of effectiveness under the proposed Large Financial Institution (LFI) rating system, which the Federal Reserve issued for public comment concurrently with this proposal.

The second part of the Fed’s proposal would apply to all banks and refocus the supervisory guidance for directors found in existing Supervision and Regulation (SR) letters. The Fed would eliminate redundant, outdated, or irrelevant supervisory expectations. The Fed intends to revise the supervisory expectations it has published in the past to guide directors. These revisions may include documents issued in tandem with the OCC or the FDIC.

The Fed preliminarily identified 27 SR letters for potential elimination or revision, which collectively include more than 170 supervisory expectations for holding company directors. The Fed intends that banks over $50 billion would be subject to different expectations than smaller banks. Smaller banks are expected to abide by SR letter 16-11. SR 16-11 includes the Federal Reserve’s supervisory expectations for the roles and responsibilities of the board of directors for an institution’s risk management, such as approving the institution’s overall business strategies and significant policies; understanding the risks the institution faces and having access to information to identify the size and significance of the risks; providing guidance regarding the level of acceptable risk exposures to the institution; and overseeing senior management’s implementation of the board-approved business strategies and risk limits.

Changes in Supervisory Expectations for Directors

The Fed indicated that it will make the following changes in their expectations for the proper functioning of bank boards of directors:

  • Emphasize the responsibility of bank management to address regulatory expectations and give directors more time to address their core responsibilities
  • Remove any expectations that directors would supervise day-to-day operations within banks
  • Clearly identify the different roles of senior management and the directors to remove confusion about responsibilities
  • Have the directors concentrate on significant firm-wide policies

Changes in How Examination Findings will be Handled

One concrete step that the Fed is proposing is to remove directors somewhat from handling examination issues. Under current practice, supervisory findings, referred to as Matters Requiring Immediate Attention (MRIAs) and Matters Requiring Attention (MRAs), are presented to the board of directors so that the board may ensure that senior management devotes appropriate attention to addressing these matters. This approach has in many cases led boards of directors to believe they should become directly involved in addressing the MRIA or MRA. The proposed guidance would indicate that Federal Reserve examiners and supervisory staff would direct most MRIAs and MRAs to senior management for corrective action. MRIAs or MRAs would only be directed to the board for corrective action when the board needs to address its corporate governance responsibilities or when senior management fails to take appropriate remedial action.

Key Fed Elements for Effective Boards of Directors at Big Banks

In the Fed’s view, effective directors:

  • set clear, aligned, and consistent direction regarding the firm’s strategy and risk tolerance,
  • actively manage information flow and board discussions,
  • hold senior management accountable,
  • support the independence and stature of independent risk management(compliance) and internal audit, and
  • maintain a capable board composition and governance structure.

For the big banks, the Fed’s proposed guidance outlines what the Fed thinks directors should do:

Set Clear, Aligned, and Consistent Direction

Directors approve the firm’s strategy and set the types and levels of risk it is willing to take. The strategy and risk tolerance should be clear and aligned.

Adopt a clear strategy with enough detail to allow senior management to understand the objectives and create an effective management team and then develop plans and budgets for business lines. Management can then establish effective audit, compliance, risk management and control functions. 

Adopt a clear risk tolerance that will enable the Risk Officer and risk management to set risk limits by concentration and types of risks.

Adopt the strategy and the risk tolerances together with a clear understanding whether the firm’s risk management capabilities are up to the task of implementing the strategies. Directors should do this regularly with existing businesses and products.

Ensure that significant policies, programs, and plans are consistent with the firm’s strategy, risk tolerance, and risk management capacity prior to approval. These significant policies include: capital plans, recovery and resolution plans, audit plans, enterprise-wide risk management policies, liquidity risk management policies, compliance risk management programs, and incentive compensation and performance management programs.

Actively Manage Information Flow and Board Discussions

An effective board directs senior management to provide information that is timely and accurate with the appropriate level of detail and context to enable the board to make sound, well-informed decisions. Directors should make it a practice to evaluate information flow and encourage management to improve the quality of information.

Individual directors may seek information outside of routine board and committee meetings through special sessions of the directors, discussions with bank staff and regulatory supervisors and through training.

Directors need to set agendas to allow discussion of options and make informed decisions, so for example an idea to start a new business should also include a discussion of the how the risks will be managed and whether audit has passed on the proposed controls.

Hold Senior Management Accountable

Directors must hold senior management accountable for implementing the firm’s strategy and risk tolerance and maintaining the firm’s risk management and control framework and evaluate performance and compensation. An effective board establishes and approves clear financial and nonfinancial performance objectives for senior management. This includes succession planning for key management.

Accountablility comes from active engagement with management in board meetings by evaluating how management supports board strategy and risk tolerance and discussing and challenging management assessments.

A board needs to look into trends in current and new businesses, how strategy and risk tolerances are observed, are persistent weaknesses in risk management and controls and aligning compensation with prudent business practices.

A board should have senior independent directors who can act as a check on senior management.

Support the Independence and Stature of Independent Risk Management and Internal Audit

An effective Board supports the stature and independence of the firm’s independent risk management—particularly compliance-- and internal audit functions and examines material or persistent breaches of risk appetite and risk limits, timely remediation of material or persistent internal audit and supervisory findings, and the appropriateness of the annual audit plan.

Maintain a Capable Board Composition and Governance Structure

An effective board is composed of directors with a diversity of skills, knowledge, experience, and perspectives. An effective board should have a process for identifying and selecting director nominees. It should do a self-assessment especially on how its key committees are performing. Where weakness is uncovered, a board should adapt its practices.

A board should be structured so it can oversee issues at the firm through its committees and contacts with management.

The board should be able to hire its own experts for advice.

                                                            *  *  *

It is long overdue to give directors a break from regulatory burdens and the Fed should continue this work and this should attract better candidates for director roles at banking organizations. Most of the guidance for the big banks should be equally applicable to small banks and we will continue to monitor the Fed’s thinking in this area.

Topics: Banking, Bank Regulations, Supervision and Regulation, Federal Reserve

About the Spotlight


The Financial Services Spotlight examines the regulatory and technology developments impacting banks, asset managers and other financial services providers—where challenges meet opportunities.

 

Meet the Authors


Roy C. Andersen, of counsel in Sullivan & Worcester's New York office, is a member of the Corporate Department. Mr. Andersen focuses on bank regulatory and compliance matters, including international banks and their branches and agencies in New York.

Joel Telpner, partner in the firm's New York office, is a seasoned advisor, strategist and problem solver. Mr. Telpner brings more than 30 years of legal experience in a career that includes time as an AmLaw 100 partner, the former U.S. general counsel of a global financial institution, and a venture capitalist. He is recognized for his ability to deftly manage complex financial transactions, especially those involving sophisticated structured finance and derivatives matters and has an extensive and unique combination of transactional and regulatory experience.

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