Few banks’ boards of directors understood the risks taken by the institutions they governed and many of those who appeared more knowledgeable may have just been lucky. The guiltiest boards, through the structure of management remuneration packages, often inadvertently encouraged excessive risk accumulation to achieve profit objectives. When risks were exposed and some errant managers exited, these same failing boards found their institutions missing capable, experienced replacements. A lack of basic banking knowledge among outside board directors has been exposed. Bank boards have traditionally been made up of leading clients, ex-politicos and community leaders. That must change.
Shareholders and regulators should demand that at least three outside directors (at every large bank) have at least 20 years of career banking experience (including ‘nuts and bolts’ experience). It can be of great value to have a mergers and acquisitions person on the board, but a few people who have signed off on a loan, underwritten a bond and understand some basics of credit risk are key, and just one such director is not enough. Large European and US banks often have boards numbering in the teens and one lone voice of knowledge will not provide a constructive engagement with managers; a core group is needed.
Selection process
Principles will help. For example, only one outside director could be a former employee and should have left that institution at least five years previously to have distance from former colleagues and decisions. This individual would put in more time than other outside directors by, for example, meeting with risk managers beyond current requirements, and perhaps having an annual meeting with regulators and attending an annual external risk seminar. They should be paid more – probably more than double the other directors’ fees because their commitments would be roughly 24 to 28 full days a year compared with perhaps 14 to 15 days for their less experienced colleagues. Regulators might also consider their own requirement for these directors to maintain state-of-the-art knowledge.
The lack of knowledge and depth among regulators on both sides of the Atlantic has been eye-popping. In the fast changing financial world, regulators who are dependent on staff that have never had ‘inside experience’ in banks are doomed to fall ever further behind in risk innovation. It is also no small issue that bank risk professionals designing risk models are probably paid many times more than what less experienced regulators are paid to assess the workings of their models. Current regimes appear an anachronism from the days of multitudes of look-alike banks that provided easy best practice comparison for regulators.
New processes
Regulators should establish a 10-year implementation process wherein an individual would need a minimum of three years’ experience at a bank regulatory authority before they could be named one of the top two senior risk managers at any large bank. Effectively, this would force banks to cycle their best risk managers through the regulators. Costs would rise for banks and regulators, but both could gain enormously through a continuing supply of experienced risk managers being proposed by institutions, and banks might regain risk managers who had substantially higher best practice experience. Regulators could also become more attractive to top graduates.
The ultimate risk that has been exposed is that many banks today look more like principal risk-taking hedge funds than traditional banks. Taxpayers are insuring or providing liquidity to debt, equity and derivatives trading books, and taking price risk on illiquid securities.
It is time to rethink what a deposit-taking institution is: whether we want them to be at the edge of risk innovation and adventurous, or very secure, dull and reliable.
Peter D Hahn is the foundation for management education fellow in corporate finance and governance at City University of London’s Sir John Cass business school. Prior to that he was a member of Citigroup’s London operating committee.
