Introduction

As a bank director, you are an important part of your bank’s governance system. Understanding your role as a director, along with the roles played by others, will provide you with a solid, basic understanding of the bank director’s place in this system and the responsibilities associated with being a director.

On successful completion of this portion of the lesson, you will be able to:

• explain the concept of corporate governance;
• list the major players in the governance process and explain the roles they play; and
• recount a bank director’s duties and responsibilities within the corporate governance system.

Review the video for a few words of advice from President Tom Hoenig on your role as a director—matters to consider, suggested things to do, and resources available to you.

Corporate Governance

Banks are organized as corporations. This business organization form allows shareholders to benefit financially through their ownership without having to be actively involved in day-to-day operations. Shareholders can rely on hired managers—family members in the case of the family owned bank used in this course—to oversee the corporation’s daily operations, while profits from these daily operations flow to the shareholders.

Clearly, this system can be highly beneficial to the shareholder. However, it also can lead to potential problems and conflicts of interests. For instance, hired managers may attempt to serve their own interests rather than those of shareholders. Instead of trying to maximize the return on shareholders’ investment, hired managers might focus on their own goals. For example, they might not take appropriate risks for fear of losing their jobs. Additionally, they might choose to enhance their own return by spending on amenities or pursuing power and prestige.

To address these potential problems, shareholders appoint directors to watch over, or govern, the managers running the corporation.

This oversight, or governance, is similar to the system of checks and balances that is built into our nation’s government. Think of the nation as a corporation and its citizens as shareholders. By voting for representatives to Congress, citizens are essentially appointing directors, who, through establishing laws, make decisions about how the business of the nation should be conducted.

This system of checks and balances, as it manifests itself in the corporate and banking world, is called corporate governance and it provides a good starting place for understanding the job of a bank director. In this regard, bank directors:

• establish policies that provide controls and limits on the various risks a bank faces;
  
• monitor those risks, through periodic reports, to ensure they remain within acceptable ranges; and
  
• oversee bank management to ensure it operates in the best interest of the shareholders and other stakeholders (e.g., employees, customers and community).
  

There are many definitions of corporate governance. Here are a few common ones that may help you understand what is meant by corporate governance.

Risk Management Systems

Risks generally associated with the safety and soundness aspects of regulatory supervision include:

• credit,
  
• market,
  
• liquidity,
  
• operational,
  
• legal and
  
• reputational risks.

Banks are required to comply with laws and regulations regarding safety and soundness and consumer compliance. Adherence to these laws and regulations is a requirement that spans the operational, legal and reputational risks.

Regardless of a bank’s size, controlling these risks requires a risk management system of some kind, whether formal or informal. The degree of formality will necessarily increase as a bank grows. Generally, a risk management system, no matter the type of risk involved, includes four basic components:

1. identification,
   
2. measurement or quantification,
   
3. controls, and
   
4. monitoring tools.

Controls take the form of board approved audits, policies, procedures, risk limits, staff training, and change management. The risk management system monitors risks, using management information systems to ensure that risks remain within acceptable ranges.

Your organizational structure is critical to the objective identification and measurement of your risks. Staff responsible for those risk management components should have reporting lines that do not compromise the integrity of the information being furnished to the board.

The "Players" in Corporate Governance

In addition to the internal players typically thought of as playing a role in a corporation’s governance, in this course we’ve added some external players. These players help shape the framework in which internal players must do their job. Understanding the parts all participants (internal and external) play will help you see where your duties and responsibilities as a director fit into the governance process. All parts of a bank are ultimately accountable to the board of directors. In turn, the board, through its oversight, is responsible for the entire bank—its financial condition, profitability and regulatory compliance.

Internal Governance Players

These governance players include individuals who have internal, direct oversight and management responsibilities for a bank. Below is a sample organization chart that shows the governance structure that typically might be found at a bank. Although the structure shown is a simplified one, it shows the reporting relationship among a bank’s internal governance players. Your bank may be organized differently from what is shown here, but the board’s position atop the governance structure will be the same.

Note that there are a number of players, working in tandem, that provide a system of checks and balances to govern a corporation. So who are the governance players and what do they do? Click on the organization chart above or the links below to learn about the roles of the internal players in the corporate governance system.

Board of Directors
CEO/President
Chairman of the Board (COB)
Chief Financial Officer (CFO)
Chief Operations Officer (COO)
Chief Loan Officer (CLO)
Chief Information Technology Officer (CIO or CTO)
Internal Auditor
Compliance Officer

Let’s take a moment to summarize what you have learned thus far: Generally speaking, a bank director’s job can be understood in terms of the role the director plays in the corporate governance system. The corporate governance system provides a set of checks and balances between members of the bank’s management team and the board of directors, who are elected by the bank’s shareholders. Although there are many internal players in the corporate governance system, all players—directly or indirectly—report to the board of directors, who are ultimately responsible for the financial condition, profitability and legal compliance of the bank.

By now, it should be clear that the board plays a key role in the governance process and a bank’s success. Given this, it is of prime importance that the board does its job well. Over the years, governance experts have identified practices that result in more effective boards—boards that do their job well. Click here to learn about effective governance practices. Additionally, there are certain practices that tend to reduce the effectiveness of board oversight. Click here for information on red flags for the board of directors.

External governance players

External players are groups or individuals—outside of a bank’s managers and directors—who inform, support and protect shareholders, and as such are part of an external framework under which corporations operate. For example, publicly traded organizations interact with the Securities and Exchange Commission, securities exchanges, financial rating services, financial analysts, broker/dealers, etc. For banks, there is an additional set of external players: the bank supervisory agencies. These agencies assess a bank’s financial condition and compliance with laws and regulation. To learn more about a particular bank supervisory agency, select one of the links below:

State Banking Departments
Comptroller of the Currency, Administrator of National Banks
FDIC
Federal Reserve System, Board of Governors

In the case of a problem bank (e.g., one in poor financial condition or one that is not in regulatory compliance) the agencies may put in place supervisory actions to address its problems. When this occurs, the directors become responsible for overseeing the bank’s compliance with the supervisory action. Most supervisory actions require the directors to submit periodic reports on the bank’s progress in correcting the identified problems.

A bank’s problems sometimes may be so severe that it is closed. In such cases, the FDIC pays depositors the amount of their insured deposits. Fines, penalties and court awards sometimes may be levied against directors for the role they may have played in a bank’s financial troubles or noncompliance with laws. Depending on circumstances, directors and officers insurance (D&O insurance) may cover some of these monetary penalties and associated legal costs. However, D&O insurance cannot, by law, cover a civil money or judgment against a director resulting from any administrative action brought by any federal banking agency. For more information, see the FDIC’s regulations at 12 C.F.R. 359.1(l).

D&O insurance covers non-bodily injury and property claims made against directors and officers arising from wrongful acts in their capacity as directors and officers of the company. For example, policies typically cover actual or alleged breach of duty, neglect, error, misstatement, misleading statement, omission or other acts. Policies won’t cover instances of fraud. The protection provided to directors and officers, however, can vary from bank to bank based on a bank’s particular D&O insurance contract. Therefore, you should read and understand what is in your bank’s D&O insurance policy so that you are aware of the personal protection afforded you as a bank director. For more on D&O insurance, click here.

Summary

Bank directors sit atop the corporate governance system. This system, which consists of internal and external players, provides checks and balances to ensure that a bank is run according to the best interest of its shareholders and other stakeholders. Internal players include the board of directors and a bank’s hired management team. External players include those groups and individuals that constitute the framework in which the governance system operates.  For banks, there is an additional key external player, the bank supervisory agencies.

Remember: In the corporate governance system, amid both external and internal players, the board of directors stands at the top. The board and its members are ultimately responsible for ensuring that the bank operates safely and soundly, and complies with laws and regulations.