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This podcast is the F D I C's YouTube Channel Corporate Governance Training.
The following is an audio version of that training.
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And now the Corporate Governance Training
Welcome to this video for board members on corporate governance.
Our goal is to focus on what you, as a director or trustee, need to
know about corporate governance, including your key responsibilities.
In this video, we'll discuss the individual responsibilities of directors
or trustees as they perform their roles.
We'll then provide an overview of corporate governance.
Next, we'll discuss the main responsibilities of the board as a whole.
Focusing on the key elements of effective corporate governance.
Finally, we'll review some of the regulatory requirements as
well as common questions the FDIC receives pertaining to this topic.
Banks need strong corporate governance in order to operate safely and soundly, with
high ethical standards, and in compliance with all laws and regulations, including
those relating to consumer protection.
Strong corporate governance is the foundation of safe and sound
operations, and this foundation lies with individual board members.
In the broadest sense, directors are responsible for the bank's overall
performance and well being and effective supervision of the bank's affairs.
Directors guide and supervise senior management's efforts to promote the bank,
build a solid reputation for the bank, and understand the needs of the community.
By electing you to the board, the shareholders, or in the case of
mutual banks, the depositors, have placed you in a position of trust.
This means that you're responsible for safeguarding the interest of the bank and
its stakeholders, including customers, shareholders, employees, regulators, and
the community where the bank operates.
A director or trustee's duty to oversee the conduct of bank business
requires independent judgment.
Board members need to make informed decisions and critically evaluate
issues that come before the board.
In addition, directors have the fiduciary duty to act in good faith and in a
manner that they reasonably believe is in the best interest of the bank.
The duties of loyalty and care are key responsibilities
of individual board members.
These duties are defined by both federal and state laws,
although state laws do vary.
The duty of loyalty requires directors to oversee a bank's affairs with
candor, honesty, and integrity.
Directors are prohibited from advancing their own personal or
business interest or those of others, at the expense of the bank.
In other words, directors have a fiduciary duty to avoid conflicts of interest.
The duty of care requires directors to exercise both sound business
judgment and good faith when overseeing a bank's affairs.
That means that directors have an obligation to use the same degree of
care that a prudent individual would use under similar circumstances.
Now, let's move on to an overview of corporate governance.
The definition of governance varies, but in general, it
focuses on people, policies, and processes that provide a bank with
strategic direction and controls.
We'll talk more about people, policies, and processes throughout this video.
The Governance Program provides the foundation for maintaining
effective risk management practices.
This helps the bank operate safely and soundly while remaining profitable,
competitive, and resilient through changing economic and market conditions.
The FDIC's view of corporate governance is long standing.
Effective corporate governance frameworks are functionally sound
and appropriate for the bank's size, complexity, and risk profile.
Community banks don't need to have an elaborate framework, and they don't
need to hire consultants in order to maintain an effective program.
Now that we've talked about the governance framework, let's talk a
little more about the responsibilities of the board as a whole.
A bank's board oversees the conduct of the bank's business.
Effective boards select, supervise, and retain competent senior management.
Establish the bank's short and long term business objectives.
and adopt policies to achieve those objectives in a legal and sound manner.
Furthermore, the board is responsible for monitoring operations and for overseeing
the bank's business performance.
All of these actions are part of establishing effective
corporate governance.
While outside directors are not typically involved in the day to day
operations of the bank, they establish goals, policies, and procedures.
that guide senior management's day to day activities.
The fundamental duties of directors are aligned with the key elements
of a corporate governance program.
Let's begin by discussing the importance of selecting and retaining
a Senior Management Team that supports the strategic direction
of the bank and can appropriately administer day to day operations.
The Board is responsible for supervising and retaining a qualified Senior
Management Team to carry out the Board's vision, policies, and strategic plan.
This includes ensuring that senior management officials have the necessary
experience and knowledge to fulfill their daily obligations and that their
performance is evaluated regularly.
Effective boards also re evaluate the bank's senior management as
well as require staffing levels and skill sets as conditions change,
such as when the bank engages in new initiatives, technologies, or markets.
Or becomes exposed to emerging risks.
Although senior management is primarily responsible for personnel
administration, including hiring and retaining staff, the board is
responsible for providing direction and overseeing personnel administration.
Primary components of effective personnel administration include a
clear organizational structure with appropriate reporting lines, position
descriptions, training and development opportunities for bank personnel,
and sound compensation policies.
and regular evaluation of senior management performance.
Succession planning is an important aspect of personnel administration.
Through the FDIC's regular examination process and community bank outreach,
we sometimes hear from directors that finding and retaining senior managers
and their successors can be difficult.
This process can be especially challenging for banks in small towns and rural areas.
Finding skilled staff may also be challenging.
A management succession and talent development plan can
help address these challenges.
These plans don't need to be elaborate to be effective.
Their sophistication largely depends on the size and complexity of the bank.
While the depth and scope of succession plans vary, informed planning is an
important component of governance.
Usually, a successful succession The board is involved in succession planning
for senior roles, while senior management handles succession planning of lower level
management, or non management positions.
A well developed planning effort involves three critical steps.
The first stage of succession is identifying key senior management
positions that are critical to the bank's continuity and success.
In this step, the time horizon for planning is established, considering
short, medium, and long term needs.
In the next step, The board would identify and assess potential successors.
For example, the board could consider promoting current staff
to key management positions,
The final step of succession planning is to consider action steps to train,
mentor, and develop personnel who might transition into critical roles.
Directors can foster development by providing opportunities
for cross training.
For serving on committees, for leading special projects, and by establishing
mentoring or coaching relationships.
External development opportunities are also a valuable tool
in developing successors.
For example, small community banks often work with local universities and
colleges to support banking courses or to offer jobs and internships to students.
Now, let's turn our attention to the concept of dominant officials.
This term describes situations where a bank official has material influence
over virtually all decisions involving a bank's policies and operations.
A dominant official can be an individual, family, shareholder, or
group of persons with close business dealings or otherwise acting together,
regardless of whether the individual or any other member of the family or
group have an executive officer title or receive compensation from the bank.
Of note, in a situation where a bank has a dominant official, A robust succession
plan is of even more importance.
That said, we would like to emphasize that the presence of a dominant
official is not automatically viewed as a supervisory concern.
For example, in some banks with limited staff, a dominant official may emerge
because no one else at the bank has the skills or abilities to operate the bank.
When a dominant official exists, the key for the board is to ensure
that an effective governance framework is maintained.
Dominant officials generally become a supervisory concern in situations
where internal controls are weak, high risk business strategies are
implemented, the official lacks sufficient experience, or board
oversight is inadequate or ineffective.
Let's discuss some of the risks directors need to be aware of when
a bank has a dominant official.
To start, the greatest risk relates to the loss or incapacitation of that official.
If the official is away for a prolonged period of time or leaves unexpectedly,
The bank may lose critical knowledge and competent management, and there
may be a short or long term business disruption, lost productivity, and
negative impacts on profitability.
And, the process to replace a dominant official can be expensive and lengthy.
The other significant risk related to a dominant official is that problems can
be more difficult to resolve when they are caused by the dominant official,
or when the official is either not responsive to corrective action, When
a bank is influenced by a dominant official, effective boards focus on
establishing a strong control environment.
Examples of controls include maintaining appropriate segregation of duties
and responsibilities, board member involvement in the oversight of policies
and objectives, and establishing independent board committees to
oversee major operational areas.
When there is a dominant official, Directors may have to ask
tough questions and engage in effective challenge discussions.
But in this process, each director can ensure that the bank's
best interests are protected.
Let's move on to the next key element of governance.
The board establishes the bank's short and long term business
objectives and policies.
This involves understanding the bank's risk profile, establishing
an appropriate risk appetite, and, working with senior management,
creating a suitable strategic plan.
Let's discuss these further, starting with the risk profile.
A community bank's risk profile is made up of many factors, including its business
model, organizational structure, balance sheet composition, and revenue sources.
External factors, such as the economy and other market conditions,
All community banks are different.
Even banks that may seem similar at first glance can have
very different risk profiles.
A bank with a higher risk profile will need stronger risk management practices
and a higher degree of board oversight.
There are several questions that members of the board may want to ask
when evaluating a bank's risk profile.
For example, are risks properly identified and categorized?
Meaning, is consideration given to high, medium, and low risk areas?
As well as to emerging risks, are risks considered for each
functional area and across the bank?
How is the bank's risk profile changing over time, and is
it evaluated periodically?
Are mitigating controls in place for higher risk areas?
Is the board comfortable with the bank's risk profile?
The answer to these questions can help the board member better
understand the bank's risk profile.
As a board member, One of your responsibilities is to voice your opinions
and concerns about the bank's risk profile to other directors and senior management.
With an understanding of the risk profile, the board can set an
appropriate risk appetite for the bank.
The risk appetite is the level of risk the board is willing to take.
The board can define its risk appetite by establishing a set of
objectives and risk parameters that guide bank activities and operations.
When determining the risk appetite, Directors need to consider the
level of acceptable risk, or potential cost to the bank, versus
an acceptable level of reward, which may be profits or other benefits.
Effective boards also evaluate the impact that the risk appetite
could have on the bank's condition during periods of economic stress.
Banks with a higher risk appetite will likely require greater
resources in terms of capital, allowance for losses, earnings,
and management and staff expertise.
While setting the risk appetite, Directors can also ascertain whether
appropriate internal controls are in place to mitigate the identified risk.
Keep in mind that the board may have to re evaluate its risk appetite
as conditions or objectives evolve.
For example, if the risk associated with an existing product, service,
or strategy changes, the board will need to determine if the activity
is still appropriate for the bank.
The board may determine that the level of risk is acceptable to the
bank and continue with the activity.
In other words, the board has determined that the level of risk and return is
aligned with the board's risk appetite.
Or, the board may decide that the activity needs to be discontinued,
indicating that the level of risk exceeds the board's risk appetite.
Likewise, when a new product or activity is considered, effective boards evaluate
the potential risks, costs, and rewards of the new product or activity Once
the risk appetite is determined, the board can focus on the development of
a suitable and sound strategic plan to guide the future direction of the bank.
Every day, community banks face challenges and opportunities as market conditions,
competition, innovation, and risks evolve.
Sound strategic planning is essential for dealing with uncertainty and change.
For most community banks.
The strategic planning process is designed so that the bank can answer
a few basic but important questions.
For example, Where are we now?
Where do we want to be?
How do we get there?
And how is success measured?
In order to answer these questions, board members will need a solid understanding
of the bank's strengths, weaknesses, opportunities, and threats, or as it
is commonly known, a SWOT analysis.
The answers to these questions are unique to each bank and are driven
by numerous factors, including a bank's culture, mission, and goals.
Business model and risk appetite.
Directors also need to consider the resources available to the bank, as
well as the bank's risk profile, size, geographic location, and customer base.
A constructive strategic planning process involves board members, senior management.
and other individuals who have an understanding of the bank's
operations, products, and markets.
Comprehensive plans include realistic assumptions regarding the current
and future direction of the bank, contain clear objectives, establish
risk limits, and set measurable goals.
Strategic plans are typically evaluated periodically, but can also be adjusted
to address changing circumstances.
The time frame covered by strategic plans vary, but a comprehensive plan typically
covers short, Medium and long-term periods a three to five year planning horizon
is common for most community banks.
A board that establishes a clear strategic vision and monitors progress
in meeting objectives provides a strong foundation for future success.
With that, let's move on to the next key element of corporate governance.
The adoption of policies that translate the Board's goals, objectives, and
risk limits into operating practices.
Effective policies address all the major operational activities of a bank,
including loans, investments, funds management, profit and capital planning.
Key bank policies also address internal controls, the audit program, information
technology, and compliance activities.
Policies covering human resources, conflicts of interest, and a code
of ethics are also important.
Keep in mind that the types of policies a bank may have and the level
of detail required for each policy will depend on the size, complexity,
and risk profile of the bank.
To be effective, policies need to be appropriate for the bank's size
and complexity, written and easily understood, communicated to all employees,
Policies are often also subject to periodic reviews by senior management
and the board, and updated as needed.
When senior management recommends changes to policies or plans, it's
the board's duty to consider how these changes could impact bank operations.
Effective boards take into account customer needs, available products
and services, results of recent audits and regulatory examinations, and
Staff expertise and external factors.
Policies and procedures are the board's instrument to establish internal controls.
Directors should ensure that the bank has a system of internal controls that
is appropriate for the institution, as required by Appendix A to Part 364
of the FDIC Rules and Regulations.
Interagency guidelines establishing standards for safety and soundness.
At a minimum, the internal control system should establish clear lines
of authority and responsibility, include an effective risk assessment,
provide timely and accurate financial, operational, and regulatory reports,
Establish procedures to safeguard and manage assets and evaluate compliance
with applicable laws and regulations.
All of these elements, working together, help the Board's efforts to identify,
monitor, manage, and evaluate emerging risks, as well as helping to protect
the bank against fraud and abuse.
Established policies typically include a way to provide the Board with information
needed to monitor bank operations.
Board members can fulfill this function.
by requiring senior management to provide appropriate information, and by
reviewing internal audits, supervisory reports, other independent reports,
and periodic reports provided to the Board and its designated committees.
An internal audit program allows directors to monitor bank activities.
An effective internal audit program is independent, sufficiently staffed
with qualified individuals, and commensurate with bank operations.
Internal audit programs at community banks can take different forms.
Some banks have an internal audit department.
While others outsource this function to a third party.
Banks with limited resources can ensure they maintain an objective internal
audit function by implementing a comprehensive set of independent reviews.
A bank employee or a board member can conduct these reviews as long as
they are qualified and independent of the function under review.
A side benefit of independent reviews is cross training and staff development
that can be part of succession planning.
The individuals responsible for conducting audits or independent reviews
may report conclusions directly to the board or to a designated committee.
Directors are responsible for evaluating audit findings and
ensuring that appropriate actions are taken to address those findings.
Effective boards also make sure that the audit program is reviewed
periodically and that it covers new product lines, higher risk activities,
and emerging areas of concern.
In addition to the other internal review reports, There are other independent
reports that directors might consider.
Common examples include the Annual External Audit of Internal Controls and
Management Reporting Systems, Periodic Loan Reviews, And regulatory reports of
examination board meetings are critical for monitoring bank operations in
advance of board and committee meetings.
Directors need to receive meaningful information with
sufficient time for review.
Generally speaking, effective boards review reports relating
to income and expense, capital levels, loans and investments,
problem loans and concentrations.
The board would also review reports for losses in recoveries.
Funding Activities, Interest Rate Risk Management, Insider
Transactions, and Compliance.
Additionally, The board would review any other information that could
have a significant impact on the bank, such as how your bank helps to
meet the community's credit needs.
When reviewing reports, directors often focus their attention on any
significant changes and the reasons for deviations from established plans.
The frequency of board meetings and reporting is not the same for all banks.
As such, Directors need to ensure that reports are tailored to
meet their informational needs and have sufficient detail to
properly monitor bank operations.
With that, let's move on to the next and last critical element of governance,
the oversight of the bank's performance.
In order to provide effective oversight, directors need to maintain independence,
participate actively, and stay engaged with the bank's activities.
Without doubt, one of the best ways for directors to participate actively
in the bank's affairs is to regularly attend board and committee meetings.
Adequate preparation and participation in these meetings is key.
Directors need to have a sufficient understanding of the issues presented
to enable them to exercise independent judgment and offer their own ideas to
the board, ask questions and follow up until they are satisfied with the answer,
voice concerns if something doesn't seem reasonable, and and communicate
any dissent from a board's decision.
It's also very important to document board reviews and conclusions and keep accurate
minutes of meetings, including directors votes on matters coming before the board.
The FDIC has a long standing commitment to keep directors
informed of regulatory matters.
The FDIC welcomes the opportunity to speak with directors and invites
you to participate in supervisory discussions held during examinations.
Please note that director attendance is voluntary.
And a lack of participation in examination meetings will not be
viewed negatively by examiners.
In addition, the FDIC often meets with the Board at the conclusion
of an examination to discuss examination conclusions and findings.
The invitation is intended to expand communication and build a solid working
relationship between directors and examiners during safety and soundness.
We've shared a lot of information with you about your responsibilities
and effective corporate governance.
Now, let's move on to regulatory requirements.
Directors ensure that management adheres to applicable regulatory
requirements and that a system to monitor compliance is in place.
The FDIC's Appendix A to Part 364, and the Federal Reserve Board's
Regulations O and W are key regulations that pertain to corporate governance.
Let's review these further.
The FDIC Safety and Soundness Standards are set out in Appendix A to Part 364
of the FDIC Rules and Regulations.
Effective corporate governance programs incorporate the standards outlined
in these interagency guidelines.
We reviewed several of these elements in prior sections of this video,
including internal controls, lines of authority, risk assessment, reporting
and monitoring, compliance with laws and regulations, and internal audit.
In addition, Appendix A requires banks to maintain prudent credit underwriting and
administration practices, have appropriate systems to identify problem assets and
prevent asset quality deterioration, and ensure that asset growth is prudent.
Appendix A also includes standards for managing the
financial aspects of the bank.
and for preventing payment of excessive compensation, fees, and benefits.
Finally, Appendix A endorses forward looking risk management practices
that promote financial integrity.
While not covered in this video, banks must also comply with the data protection
responsibilities detailed in Part 364, Appendix B of the FDIC Rules and
Regulations, which sets forth criteria for a bank's information security program,
risk assessments, and board reporting.
Now, let's briefly review Regulation O and Regulation W, which apply
to all FDIC supervised banks.
Regulation O covers transactions between a bank and its executive officers,
directors, or principal shareholders.
In contrast, Regulation W addresses transactions between a bank and its
affiliated business organizations.
The basis for these transactions must be fully documented.
As a general rule, Transactions with insiders and affiliates must be
beyond reproach and subject to the same objective criteria offered to
ordinary customers and third parties.
Directors are responsible for ensuring compliance with these regulations,
which may result in the adoption of policies that prevent preferential
transactions, conflicts of interest, inappropriate self dealing, Now,
let's review some questions the FDIC frequently receives regarding director
responsibilities and corporate governance.
First, how can board members foster a culture of regulatory compliance?
Let's start by saying that directors are not expected to be personally
knowledgeable of all laws and regulations.
Let's But they need to make certain that high ethical standards and
compliance with all laws and regulations, including those relating to consumer
protection, The tone for our culture of compliance is set at the top.
Effective boards also adopt policies, procedures, and controls that are
consistent with regulatory requirements.
This includes processes for monitoring bank activities and
detecting noncompliance, as well as personnel training that promotes
compliance in daily operations.
In addition, Staying apprised of compliance related matters is a
key aspect of board oversight.
Violations of laws and regulations can reflect negatively on the board
and management, and can expose a bank to financial and other risks.
If violations occur, directors need to ensure that comprehensive,
corrective actions are implemented as quickly as possible.
and that processes are reviewed and updated as necessary
to prevent reoccurrence.
Another question we receive is whether board members can be held
personally liable for a bank's noncompliance with laws and regulations.
Regulatory enforcement actions against bank directors are rare.
Similarly, most civil actions involve former directors of failed
banks where there was a demonstrated failure of the directors to satisfy
their duty of loyalty or care.
Depending on state law, Directors may be personally liable for breaches of trust,
fraud, gross negligence, negligence, abuse of power, and asset misappropriation.
In all cases, they Legal actions are not taken lightly, and the
FDIC will only pursue such actions after rigorous investigation.
Board members who fulfill their duties and responsibilities are unlikely to
face legal actions initiated by the FDIC.
The last question we'll cover today is, are there any common
areas of risk or concern pertaining to corporate governance?
Potential signs of risk or concern may include reluctance from senior management
to engage with directors, Repeat audit or examination deficiencies, frequent
exceptions to policy, deviation from established plans, or board members
receiving insufficient information.
It may also include situations where fluctuations in financial
trends, personnel management issues, or consumer complaints are noted.
As we conclude our discussion on corporate governance, we'd like
to remind you that the FDIC has additional videos and resources.
which can be found on the Banker Resource Center at www.
fdic.
gov.
Directors can also keep up with industry developments by participating in trade
association events and by staying abreast of local, regional, and national news.
If you have questions or comments, please contact your bank's Risk Management Case
Manager or Compliance Review Examiner or email the FDIC at supervision at fdic.
gov.
Thank you for viewing this video.
We hope you found it both useful and informative.