Guiding lights for banks: non-executive directors
What do non-executive directors on banks’ boards and lighthouses have in common? They both oversee, guide and support operations while keeping a healthy distance. For lighthouses this means guiding ships effectively without being at sea. For non-executive directors it means overseeing and controlling the management of banks without themselves performing management actions.
This analogy has its limits, however. While lighthouses have largely been rendered obsolete by more modern guidance systems, the oversight function of non-executive directors is as crucial as ever. In fact, the importance of effective oversight of banks has increased – and not only in response to the financial crisis. Today’s non-executive directors must deal with a more complex business environment, a faster pace of change, new technologies and higher regulatory requirements. In addition, regulators, banks and investors expect them to be more proactive in ensuring the sound and prudent governance of banks.
Governance and the oversight role of non-executive directors are key areas of attention for ECB Banking Supervision, and are assessed as part of ongoing supervision in the form of the Supervisory Review and Evaluation Process (SREP) and thematic reviews on governance. Fit and proper assessments, jointly conducted by the ECB and the national competent authorities, are another important supervisory tool in this respect.Guide to fit and proper assessments
New non-executive directors are assessed against five criteria, taking into account the specificities of the bank and the position being filled. In the final supervisory decision, the ECB may impose additional conditions, obligations or recommendations to address concerns identified during the assessment. These must be followed up by the bank.
Percentage of appointees with conditions, obligations or recommendations imposed in ECB fit and proper decisions
Recurring areas of concern identified for non-executive directors are:
- time commitment: for example, a very high number of mandates and/or low time commitment to the role;
- experience: for example, lack of basic banking knowledge;
- independence of mind: for example, financial conflicts of interest and/or mandates held in clients of the bank.
Round-table event recognises best practices
ECB Banking Supervision regularly exchanges views with the industry on questions of governance and fit and proper supervision to identify further room for improvement. Most recently, the ECB welcomed non-executive directors and corporate secretaries of banks to a round-table event under the headline “fit and proper for better oversight”. The discussion focused on the responsibilities and challenges of non-executive directors and recognised a number of best practices.
Attendees agreed that non-executive directors should follow the “nose in/fingers out” approach. They should be well informed about all the activities of their bank, actively seek out information and challenge the proposals of executive managers if necessary (“nose in”). In this context, members of risk and audit committees should have close and regular contact with the heads of internal control functions. At the same time, non‑executives must be careful to avoid becoming directly involved in the running of the bank and acting as a second executive team (“fingers out”). Participants agreed that there was room for improvement for both aspects. In many banks non-executives are still too passive and do not effectively challenge management decisions. In some cases, however, they intervene too much, blurring the boundary between the supervisory and management functions. Participants also observed that non-executive directors can actively contribute to the development of an adequate risk culture in banks and should monitor that behaviour is in line with ethical standards at all levels of the bank. Their role and the way they perform it is a key element of supervisors’ assessment of the overall functioning of the board as part of the SREP, since it may affect several aspects, such as quality of debate and accountability.
Another point of agreement was the importance of appointing the right people to non‑executive roles. As the individual responsible for coordinating the board and committees and interacting with all stakeholders, the chair of the board should have certain soft skills – time management, decision‑making, the ability to moderate meetings and stakeholder management – as well as essential subject knowledge. Candidates for the position of chair of the audit or risk committees should have high levels of technical knowledge in the areas of risk appetite-setting and management, and in auditing and compliance.
The round-table discussion also touched on the responsibilities of banks’ nomination committees, which should play a leading role in defining and implementing appropriate internal suitability policies – sets of bank-specific rules on how directors are selected, assessed and appointed. Participants pointed to the need for a high degree of flexibility in selecting candidates, taking into account the needs of the bank and the current composition of its board. While experience in banking was considered to be the most important criterion, soft skills and experience in other sectors, such as IT, were acknowledged as becoming more and more relevant. Banks’ internal policies and the ECB’s fit and proper assessments should take this into account. ECB Banking Supervision recognises the benefits of diverse profiles for non-executive directors and considers that a lack of banking experience may be addressed by appropriate induction and training programmes.
Bank representatives participating in the round-table appreciated the open and constructive dialogue and recognised the contribution of European banking supervision in improving governance supervision overall and in conducting fit and proper assessments in particular. They also stressed the need for supervisors to apply proportionality in supervision, given banks’ different business models, size and complexity. ECB Banking Supervision shares this view.
ECB Banking Supervision will continue to raise the bar on what counts as sound governance to ensure that banks follow international best practices. For this purpose, it will continue to regularly exchange views with the banking industry, focusing not only on the past crisis but also on the governance challenges that lie ahead.