The bulk of the principles behind good corporate governance originated from the banking and financial industries. That’s precisely why the relationships between risk management and corporate governance for banks, credit unions and other financial institutions are so vastly different from those of other industries. It’s this distinct difference that has many people wondering if the current principles of corporate governance have long been doing other types of industries a viable injustice.
The Nature of the Industry Sets Banks and Credit Unions Apart
Just what makes banks and credit unions so different from other industries from a risk management and corporate governance perspective? As a rule, executives and managers in the banking and finance industries tend to have higher qualifications and expertise in governance, risk and compliance. The banking and financial industries also have some of the most experienced financial experts, with many executives having extensive careers in finance. Since banking firms generated most of the current governance principles, the banking industry is often the first and most affected by changes. Another notable difference in the banking industry is that the decisions of the board affect the shareholders, creditors and banking customers. This is especially true in the case of credit unions, where the members are part owners of the bank.
As banks deemed “too big to fail” toppled during the financial crisis, smaller financial institutions took note of the importance of branding and reputation. What makes banks and credit unions similar to other industries is that they must take some degree of risk to experience growth and please their shareholders. This calls attention to a couple of questions. How can boards structure their executive remuneration to encourage responsible risk-taking? Should corporate governance principles be changed to more broadly affect all types of industries?
One thing is certain: Risk management and corporate governance are in a period of evolution in the financial sector, which will affect all other industries.
Potential Changes on the Horizon for Corporate Governance
Among the thousands of financial and governance experts, there is much agreement that it’s time for corporate governance principles to line up better with the degree of risk-taking. Many of the discussions on Wall Street center on enhancing corporate governance principles in ways such that they have structure, integration and balance. If there’s a divide, it’s that some experts would also like to see corporate governance principles that can be more broadly applied to all industries, rather than focus so heavily on the financial sector, leaving the details up to each industry. Others would like to see new governance principles that are specific and stringent.
Banking institutions learned a very important lesson when large companies like Merrill Lynch, Fannie Mae, Freddie Mac, AIG and others faced bankruptcy some years ago. Banks and credit unions are now aware that they need to identify, monitor and manage catastrophic risks, even when there is a low chance of a similar situation occurring in their company.
Exploring ways to deal with reputational risk is an issue that plagues all industries, including banks and other financial institutions. Discussions are occurring across industries about how they can take a more organized approach to reputational risk. One theory is to infiltrate risk management starting at the bottom of the organization, which is contrary to the commonly used top-down approach. The thought is that managers could play a stronger, more strategic role in getting a buy-in from their employees about the importance of protecting the firm’s reputation.
Changing the Face of Remuneration Among Bank and Credit Union Executives
As with most other types of businesses, the most natural place for banks and credit unions to consider making changes is to its executive remuneration policies. Such changes to come may include tying risk management to reward structures. Specifically, changes would financially reward managers who have an awareness of risk management, who avoid taking unnecessary risks and who yield positive long-term growth for the company. In addition, remuneration structures may factor in how well managers view and plan for reputational risks.
Corporate Governance Changes Create New Challenges for Banks and Credit Unions
Banks and credit unions are aware that not one, but many, situations came together at once to create the financial crisis. Companies made acquisitions at extremely high prices; executives were motivated to take larger risks; the real estate market took a nosedive; the recession hit; and governments bailed out companies in order to protect the public. Banking decisions were also often influenced by politics. Boards of banks and credit unions are aware that new issues, along with these issues, can surface at any time.
New Perspectives on Risk-Taking and Corporate Governance
New industry terms are bound to develop as corporate governance begins to take on a new shape. Common language will help banks and credit unions to devise new standards for measuring and balancing their approach to risk.
Bank and credit union boards will need to work harder to be the best stewards of their customers’ and shareholders’ funds, being cognizant that the potential for catastrophic risk is always lurking in the background. Financial institutions will be continually challenged to create an optimal level of value despite political and economic influences.
Risk Management and Corporate Governance Changes: Bringing It All Together
While the lion’s share of corporate governance principles emerged from the financial industries and they’ve continued to serve all industries in recent decades, the current opinions are trending toward moving toward changes that better apply to all types of industries. Governance for banks has always been different than for other industries, and no one expects that to change. Board directors will have to continue to find ways to fulfill their responsibilities toward creditors, shareholders and customers.
New approaches to developing corporate governance principles will certainly consider the effect of risk-taking and how businesses motivate their executives to balance risk with growth. How corporate executives manage reputational risk will play a higher role than it has in past years.
Whatever the changes bring, there are some thoughts that the banking and credit union industries will benefit better with corporate governance enhancements that reflect all industries. A broad-based approach would set some general standards, while leaving room for specific industries to fine-tune standards for their own sectors.
