In the light of recent bank failures, it appears that when it comes to the governance element of ESG, the practice is not matching the theory.
How did we get here again? From classic asset-liability mismatch at Silicon Valley Bank, to structural failures in internal controls at Credit Suisse, we’re still faced with the same questions about governance. So how do we ensure effective board oversight and responsible executive performance?
Admittedly, banks are inherently risky, complex and highly levered businesses – so running such institutions is no mean feat. The rigour and focus required are immense. For example, banks would now be thinking hard about updating their liquidity metrics in the context of stealth speed of information, taking stock of the fast bank run experienced at Credit Suisse and, more recently, SVB.
Moreover, the complexities involved in managing a portfolio of businesses with different risk profiles are vast: contrast, for example, a risk-focused trading floor with a fee-based advisory business. If all performance expectations ultimately rest on the bank’s CEO, it makes sense to ask what sort of business background should be expected of chief executives and their successors.
And in order to ultimately safeguard a bank’s governance, there should be expectations on what key attributes its board directors should display: they should be proactive, forensic and intimately involved. For instance, it would be instructive to count how many emergency risk board sub-committees were convened at peer banks in the past two weeks, following bank failures on both sides of the Atlantic (see First Republic Bank, among others), sharp bank stock devaluations (see, for example, Deutsche Bank) and reports of continuous deposit withdrawals.
It would also be interesting to find out how many banks are in the process of updating their risk registers and heat maps, in order to raise the level of sophistication and effectiveness.
While these are naturally confidential discussions, governance circles are wondering why it took so many incidents and fines before greenwashing was added to some banks’ risk registers (see HSBC in February 2023). It is also a fair question to ask shareholders how they got comfortable with such lacklustre performance, and what further questions were raised.
Best practice vs reality
Best practice prescribes that directors have their fingers on the pulse of the organisation. Accordingly, they make a point of “walking the floor” frequently and connecting down three levels of seniority below the executive committee, in order to gauge the “tone” across the firm. Directors also aim to look through board papers, understand what is critically missing, and make resolute and timely interventions.
Against this backdrop, however, in 2020 alone we witnessed stark incidents of prolonged and widespread fraud. Wells Fargo was fined for extensive consumer abuses, while Standard Chartered and several other mega-banks were fined for money laundering and sanctions breaches. These scandals had apparently been going on for years, yet caught board directors acutely unaware.
Clearly, there is a huge gap between governance theory and practice. At this juncture, regulators, investors and peer boards would do well to ask critical forensic questions on topics such as: the quality and depth of board discourse through material examples; key board performance expectations and standards set by the chair on structural issues; instances of how executive failures are escalated and dealt with at the board; and hard evidence that organisational processes are effective.
Invariably, resolve at the board level would also have to be signalled through clawbacks in executive compensation.
Does whistleblowing work?
Delving further into process effectiveness, whistleblowing is meant to afford ultimate protection to an organisation. However, the existence of the process is less of an assurance – in 2018, the CEO of Barclays, Jes Staley, breached the bank’s whistleblowing process – than statistics on how many times the process is triggered, to whom it escalates, what remedial actions are taken, and how fast this is done.
Credit Suisse was well acquainted with material instances of whistleblowing, as seen by the 2022 scandal on client information leaks. Meanwhile, some employees had apparently escalated their worries about malpractices related to Greensill Capital. Yet, here again, governance theory and practice are diverging significantly.
Directors, investors and regulators should aim to monitor output performance indicators with curiosity at banks, such as the statistics and patterns of misconduct, associated materiality, and the number of open enquiries. Generalised statements about annual compliance trainings don’t add much value, and it should be noted that receiving mute responses or near-perfect statistics are invariably signals to dive much deeper at an organisation.
Moreover, given the level of complexity at banks, subsidiary boards should play a prominent role in increasing monitoring granularity. Yet in practice, how do regulators and investors satisfy themselves that subsidiary boards take initiative and operate proactively?
Having interviewed subsidiary directors at banks over the past few years, it is interesting to observe how frustrated many appear to be. Main boards have a clear accountability to set and communicate rigorous performance expectations of their subsidiary boards.
In short, while governance best practice could have avoided many bank failures in the last few weeks and over the last three years, it is evident that in practice, governance is underperforming significantly.
Better self regulation
Given the huge costs involved in bank bailouts, it makes sense to raise the bar on director accountability and for boards to self-regulate better before it gets to that point. Proactive director appointments and votes; a more disciplined look at directors’ track records; more transparency on board performance; and, finally, breaking the “pale, stale” director nexus should all help to change the tone in the boardroom.
Ultimately, court cases exposing directors’ liability, which are expected to appear across the banking industry based on examples in other industries (see the Shell, Boeing, McDonalds cases, among others), and a more material tie between governance metrics and remuneration, for the C-suit as well as directors, should help to align interests better.
In the meantime, regulators will do well to apportion responsibility publicly to the bank officers and directors involved in recent failures. For them to go unaccounted for may otherwise be one sour experience too many for the general public to tolerate.
In a society where the doctors and nurses who kept us afloat during a devastating pandemic now struggle to keep up with the rising cost of living, it is unthinkable that corporate directors’ poor performance leads to little or no personal consequences.
Tina Mavraki is a chartered portfolio director with the UK Institute of Directors, and a strategic advisor on climate and ESG governance