Enhanced dialogue between Boards and Supervisors: Towards a sound governance framework
Speech by Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism,
at the SSM Conference on governance and risk appetite,
Frankfurt am Main, 23 June 2016
Ladies and gentlemen,
Welcome to Frankfurt. I am very pleased to see all of you here today at the SSM Conference on governance and risk appetite.
The term “corporate governance” first appeared in 1984, in the title of a book by Robert Ian Tricker, who later co-founded an international journal dedicated to corporate governance. In his words: “if management is about running the business, governance is about seeing that it is run properly”.
In general terms, governance provides the checks and balances that are indispensable for good decision-making. It balances opposing views, counters excessive risk-taking and helps institutions to maintain a sustainable course. In short, good governance is good for everyone.
Consequently, European banking supervision has made internal governance one of its top supervisory priorities. It is, for instance, one of four central elements of our Supervisory Review and Evaluation Process, or SREP for short. In addition, we have conducted a thematic review on risk governance and appetite, in the course of which most of you have been interviewed, and even challenged, by our Joint Supervisory Teams.
Today I would like to clarify our expectations towards internal governance, focusing on two elements which are essential parts of any stable governance framework: first, supervisory bodies within companies and their interaction with management bodies; second, risk appetite frameworks, or RAFs.
Internal governance – Bertrand Russell’s question mark
As Bertrand Russell said: “In all affairs it's a healthy thing now and then to hang a question mark on the things you have long taken for granted.” This is an apt description of the task of supervisory bodies within banks, whether they be called boards of directors or supervisory boards.
The quote also captures the essence of our expectations regarding the role of these boards. We expect them to oversee, challenge and approve how the management pursues the bank’s strategic objectives, how it implements the governance framework, and how it shapes corporate culture.
In order to live up to these expectations and to perform their role, supervisory boards have to be independent and intrusive; they have to be impartial and, at times, troublesome; they have to ask questions and they have to exert judgement. Eventually, they have to become an independent voice that is heard by senior management. And we expect senior management not only to hear that voice, but also to react to it and to adjust decisions where appropriate. At the same time, we expect supervisory boards to set the right tone from the top, which can then filter through to the middle and lower levels of the organisation.
This role of supervisory boards is consistent whatever their name or structure. I have often been asked if the SSM has any preference regarding the boards’ structure. The answer is no, we do not have any preference and we fully acknowledge the differences in national legal frameworks. Indeed, a central conclusion of our thematic review is that effective governance is possible in any corporate model, regardless of its structure.
In line with the Capital Requirements Directive, we also expect supervisory boards – or boards of directors – to perform periodic self-assessments. Such self-assessments allow them to reflect on their functioning, practices and internal dynamics. The results of such self-assessments should then be formally discussed during board meetings.
Risk – controlling the appetite
Ladies and gentlemen, internal governance and risk management have a critical impact on an institution’s overall risk profile and the sustainability of its business. This is particularly true in the current environment of very low interest rates, sluggish economic growth, increasing competition and a changing regulatory landscape. The resulting headwinds might induce banks to embark on a search for yield and venture into ever riskier territories.
Against that backdrop, we expect banks to develop and establish a comprehensive risk appetite framework as a key instrument to strengthen risk awareness and promote an adequate risk culture. In general, we observe that banks under the ECB’s direct supervision need to continue their efforts to implement effectively their respective RAF across their organisation.
And also with regard to the RAF, boards play an essential role. They should be actively involved, not only in approving the RAF, but also in monitoring its implementation. In particular we expect boards:
- to ensure that the RAF defines the types and level of risk the institution is willing to take regarding both financial and non-financial risks;
- to ensure that risk metrics and limits are applied consistently within entities and business lines, that they are monitored and regularly reported to the board;
- to ensure that the RAF is aligned with the institution’s business plan, with strategy development, capital planning, recovery planning and with compensation schemes.
Still, we seek a deeper and more nuanced understanding of how the management bodies work, how key decisions – particularly on strategy, risk management and appetite – are reached and how the relevant debate is conducted. All this serves to shed light on the effectiveness of a firm’s risk governance process. The discussions we will have in the course of today are also a good opportunity for us to address these issues and to learn from each other’s perspective.
Banks’ boards and supervisors – fostering the dialogue
After all, supervisors and board members share very similar objectives. Therefore we expect trustful interaction, based on clear mutual expectations, open communication and predictable behaviour.
Our Joint Supervisory Teams stand ready to provide feedback to individual institutions on the results of specific investigations. Likewise, we expect boards to be proactive in engaging with supervisors in both formal and informal discussions about their bank’s strategy, its risk management framework and the effectiveness of the supervisory boards themselves. We also expect boards to set the tone for effective interaction of senior management with supervisors, and to ensure that senior management engages proactively and positively with supervisors.
How can we foster such a dialogue beyond today’s conference? In my view, the most promising approach would be a programme of regular meetings, supplemented by informal contacts as appropriate. Indeed, in the context of our annual Supervisory Examination Programme, the Joint Supervisory Teams have put in place a programme of meetings with both management and supervisory bodies. These meetings are held at different intervals, depending on the complexity of the relevant institution and any existing issues. But of course, the relationship between Joint Supervisory Teams and the management and supervisory bodies of the institution they supervise is always tailored to the institution’s particularities.
Furthermore, from time to time, supervisors may attend all or parts of board meetings as observers. This allows them to observe, in a more practical sense, how effectively a board is functioning and to occasionally attend discussions on topics that are of particular strategic importance.
We believe that this approach strikes a balance, enabling us to assess the effectiveness of supervisory boards without interfering in the regular governance process of the institution. That said, supervisors might also attend board meetings in order to present certain issues such as the outcome of the SREP, specific concerns regarding risk or other supervisory findings.
Supervision – recent initiatives in the area of governance and risk management
And that takes me to the final part of my speech: recent supervisory initiatives in the area of governance and risk management. I already mentioned our thematic review on risk governance and appetite that was launched in 2015 and in which most of you have been involved.
I believe that this thematic review finely exemplifies what European banking supervision is about, namely the promotion of best supervisory and corporate practices across the euro area.
- The thematic review covered 113 significant institutions, under a consistent supervisory approach, thereby contributing to a level playing field based on national and European regulations and on international best practices.
- At the same time, the thematic review acknowledged the proportionality principle, taking into account the complexity of institutions and differences in national legislation. Following a forward-looking, risk-based and judgement-based approach, it took into account the particularities of the governance structure of each institution. It has also paved the way for other investigations, in the governance area or on other related supervisory matters which emerged during the assessment.
- The thematic review combined a vertical perspective, gained from the assessment of bank-specific findings by each Joint Supervisory Team, with a horizontal perspective, resulting from the aggregation and comparison of bank-specific findings. It has enabled us to draw aggregated conclusions, identify good practices and issue consistent recommendations across the euro area. It definitely helps us by clarifying our supervisory expectations, and it helps you by illustrating best practices across the industry.
- And finally, the thematic review was action-based and therefore has a direct supervisory impact. I know that most institutions are now in the process of implementing the review’s recommendations. We are, of course, monitoring closely the progress of that implementation.
Beyond the thematic review and the SREP, we have undertaken still other initiatives in the field of governance.
- We have, for instance, developed a common fit and proper framework for assessing the suitability of individual board members. That framework builds on best practices while respecting national legislation. We have also developed a policy stance for assessing the collective suitability of the board as a whole. This helps to promote good governance at the level of the entire board.
- Furthermore, we have strengthened our methods for assessing remuneration policies and implementing the European Banking Authority’s rules on “identified risk-takers” and the impact of variable remuneration and discretionary dividend distribution on the sound capital base. We strongly believe that both financial and non-financial incentives are critical for reinforcing a sound governance and risk culture.
- While not directly responsible for consumer protection and financial market integrity, we closely monitor the implications of legal, reputational and misconduct cases on banks’ governance, culture, compliance, and financial risk profile. At the end of 2015, we performed a survey on conduct risk which analysed past and open legal cases that have led, or could lead, to considerable costs for significant institutions.
- And last but not least, a thematic review on the implementation of the Basel principles on data aggregation and reporting is also being performed on several significant institutions. We view this exercise as an extension of our work on risk governance and risk appetite, as both depend on sound risk reporting and high-quality risk data.
Ladies and gentlemen, I think we all agree that good governance is essential for any organisation that is seeking to generate sustainable returns. That is why we have made governance one of our top priorities. In my speech, I have laid out our expectations regarding banks’ boards and risk appetite frameworks, and I have briefly discussed some of our recent initiatives in the field of governance.
All our work so far has been a starting point. Much progress has already been made, with regard both to our interaction with boards and to our assessment of the effectiveness of banks’ governance structures. Over the coming months, we will continue our regular and proactive interaction with management bodies. And today’s conference offers another excellent opportunity to exchange views on governance and risk appetite.
Thank you very much for your attention.
- “Corporate governance principles for banks”, Basel Committee on Banking Supervision (2015).
- “The Role of Personal Accountability in Reforming Culture and Behavior in the Financial Services Industry”, Christine Lagarde, Managing Director, International Monetary Fund, Speech at the Federal Reserve Bank of New York, 5 November 2015.
- “Toward Effective Governance of Financial Institutions”, G30 (2012).
- “A New Paradigm”, Financial Institution Boards and Supervisors, G30 (2013).