How to Transform Governance for Your Bank or Credit Union

Nicholas J Price

It’s natural to resist change, and while the current economy places much emphasis on good governance, transformation in governance is happening much too slowly in many industries, including banks, credit unions and other financial institutions. For the most part, shareholders aren’t feeling satisfied that current forms of governance go far enough to protect the interests of minority shareholders. The financial market stakeholders have hinted at greater accountability and made repeated suggestions for it. This focus on improving governance has primed banks and credit unions for change. The pressure is on for financial institutions to embrace change and to take individual responsibility for having greater accountability toward shareholders before legislative changes occur that force them into it.

The standards for good governance are clear. Banks and credit unions merely need to incorporate them into their best practices. While we tend to lump banks and credit unions into one category, standards for credit unions may not work as well in practice as for banks because they’re owned by members rather than shareholders.

How Banks and Credit Unions Can Move Closer to Improved Governance

Board directors can look at improving governance within their people and their reporting. Improving governance means taking an objective look at board composition and at the skills of the board directors and managers and being willing to make changes as necessary. In addition, banks and credit unions need to place a heavier focus on comprehensive reporting and transparency.

Banks May Need Larger Boards Because of Regulatory Requirements

New best practices for corporate governance suggest that smaller boards, when they have the right talent and composition, are more productive than larger boards. While smaller boards are better for most industries, banks and credit unions must comply with heavy regulations, which requires more expert financial expertise than other industries. Banks receive most of their income from debt, and the failure to manage financial matters causes a negative impact on the economy and the community, as well as its shareholders.

Board sizes typically range from about nine to 14 members. Boards for banks usually need to be larger because they need a higher level of expertise. C-suites for banks are also getting larger, which is giving boards of banks a larger pool of candidates from which to choose. While capping the number of board directors makes good governance sense for other industries, banks need more flexibility in the size of their boards in order to get the necessary skills for sound decision-making.

The caveat with larger boards is that it’s easier for some board members to be less participatory than other members. To improve governance, boards of banks should require minimum attendance at board meetings. Board chairs should keep a watchful eye over board directors who are not active participants in board meetings.

Independent Directors Chosen for Their Specific Talents and Abilities

Shareholders are insisting on larger numbers of independent board directors, which reflects good governance. Because of the extra financial expertise that bank boards need, they should look for independent board directors with specific skill profiles whose experiences truly enhance the board.

Independent directors play a specific role in governance. Board evaluations require objectivity, so best practices suggest that non-independent directors should not assess independent director performance.

Annual Performance Evaluations Are the Norm in Good Governance

One of the notable parts of the Companies Act of 2013 in India is that board directors and committees should conduct annual performance evaluations. Conducting annual performance evaluations is a relatively simple way for banks and credit unions to start making some improvement in governance.

Transparency and Accountability Play Large Roles in Transforming Governance

There is much concern about the banking industry needing to be more transparent and accountable. There are too many occurrences of boards that produce reports that only tell the good news. Shareholders complain that banks are withholding too much information about nonperforming assets. Shareholders and others would recognize improved governance by seeing the dissenting views of independent directors regarding investments, acquisitions, related transactions and clear risk profiles.

To improve trust with shareholders, boards should state how they will be accountable for key business parameters at the beginning of the year. This is a best practice that will instill objectivity in the performances of all board directors.

Keep Management Separate From Shareholders

Shareholders and other stakeholders perceive improved governance when companies make it a point to separate management from shareholders. This is especially true for companies that have many family members serving on the board. Current movements in governance account for selecting individuals in the C-suite who have minimum qualifications and experience for larger companies with larger amounts of capital as candidates for directorship.

Transformation Means Revealing the Details in Addition to the Big Picture

Shareholders have made it clear that they want more information and that they want to receive it in clear, understandable ways. In addition to seeing the big picture, they want to see results from the subsidiary companies in their financial reports.  Seeing clear narratives and explanations for changes based on information in the reports would be a welcome trend toward improved governance.

Corporations lose trust in their shareholders when they try to mask the impact of nonperforming assets. For companies that lack capital and that have low buying power, improved governance would be reflected in special codification for nonperforming assets or assets that are trending toward becoming nonperforming assets.

Credit Union Transformation Offers Unique Governance Challenges

Credit unions face the same risks and challenges as banks. They’ve proven that they make contributions to the stability of the financial services industry in a slightly different way.

The same governance standards that work so well for other industries also work well for banks. Because credit unions are member-owned, they may not be able to stand up to the rigor of the new regulations. Improved governance for credit unions needs to take into account that the board nominating process and the composition of the board affects the board’s accountability to its members. For credit unions to transform governance, we must consider the differences in the institutional ownership and business model. The risk in trying to impose a one-size-fits-all model of governance could expose credit unions to unnecessary risks and render them less effective.

What is the Governance Cloud?

Board directors of banks and credit unions are obligated to perform a host of varied duties and responsibilities in order to maintain best practices for corporate governance. Diligent has developed a suite of governance tools to help them fulfill their responsibilities accurately and efficiently. The Governance Cloud ecosystem of products includes:

As board directors, leadership teams and general counsels continue to express their needs to digitize governance processes, Diligent will be the partner to grow with them. Collectively, these tools enable corporations to achieve a fully digitized and integrated governance ecosystem to mitigate risk, plan for strategic growth and ultimately, govern at the highest level.

Wrapping Up Transformation of Governance for Banks and Credit Unions

Transforming governance is good for shareholders, managers, employees, boards and the economy. Challenges and trends in the banking industry lead the way for the issues that other industries face. Transformation within the banking industry will likely make it that much easier for other industries to follow suit.

Banks will need to transform their practices regarding board size, composition, transparency and accountability.

Regulatory bodies and legislators will also need to factor in the unique role and framework of credit unions in defining what corporate governance practices work best for the institutions, their members and the community.

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Nicholas J. Price
Nicholas J. Price is a former Manager at Diligent. He has worked extensively in the governance space, particularly on the key governance technologies that can support leadership with the visibility, data and operating capabilities for more effective decision-making.