What does the ECB expect from banks’ leaders?
Speech by Edouard Fernandez-Bollo, Member of the Supervisory Board of the ECB, Florence School of Banking and Finance online seminar “Fit and Proper Assessment: Better Boards for Better Banks?”
Frankfurt am Main, 19 February 2021
The first Chair of the Supervisory Board, Danièle Nouy, used to call fit and proper assessments the “enfant terrible” of banking supervision, and for good reason.
When looking at whether an appointed member of a bank’s management body is suitable for directing the bank’s business, ECB supervisors have to comply with 21 different national frameworks, not a single European rule. Fit and proper (or FAP) criteria are laid down in the Capital Requirements Directive (CRD IV), meaning that, in accordance with EU law, each Member State has a certain level of flexibility when transposing the content of CRD IV into national legislation.
To give an example, in 8 out of the 21 countries participating in European banking supervision, FAP assessments are conducted after an appointee has taken up the position; these are known as ex post assessments. In 13 countries we have to work against legal deadlines, some of which are only 30 working days, so extremely tight. At the other end of the spectrum, eight countries do not set any deadlines at all. Since the inception of European banking supervision the number of FAP assessments we carry out per year has increased from 2,500 to almost 3,000.
This situation is clearly not conducive to the consistent application of a unified European approach to governance. Therefore, the ECB will continue to push for fully harmonised fit and proper criteria that would be enforced through directly applicable EU legislation.
But we are not standing still in the meantime: in 2021 we will be enhancing our approach to FAP supervision because we see this as a tool to better support a much-needed improvement in banks’ governance. This enhanced approach can only be properly understood when considered together with our view on the role and mission of a bank’s management body.
The ECB’s view on banks’ leadership
The members of a bank’s management body have different functions. Executive board members make decisions while non-executive board members monitor and oversee those decisions. This balance is key to the safe and sound management of a bank and requires each member to demonstrate both collective and individual leadership.
Collective leadership means that every decision should be based on a wide range of information and available data. This is difficult to achieve if all members of the management body have a similar background and similar expertise, as they risk overlooking issues that fall outside their professional experience. A broader range of experiences, values, abilities and backgrounds could help management bodies improve their risk-taking, innovation, customer orientation and decision-making. And new challenges require new skills: with the increasing importance of climate change and digitalisation, for example, banks’ boards would clearly benefit from actively adding members with relevant experience and skills in these fields.
Diversity within a management body is therefore crucial: it is not just a fad, it is a global trend that has gained pace because the world has started to fully understand the benefits it brings. But there is a lot of room for improvement in this area in European banks. Looking first at gender diversity, where action is clearly needed, the benchmarking exercise conducted by the European Banking Authority (EBA) revealed that of the 834 credit institutions and investment firms they examined, two-thirds have executive directors of only one gender and over 40% have not yet adopted a diversity policy at all, despite the provisions of the CRD IV. This situation is simply not acceptable to us as supervisors.
In addition, data suggest that a lack of gender diversity leads to inefficiencies. According to the EBA, around 55% of banks with a more gender-balanced selection of executive directors have a return on equity (ROE) of 6.42% or higher, while only 41% of banks with executive directors of just one gender reach this level. Moreover, the average ROE of banks with gender-diverse management functions is around 1.3 percentage points higher than that of banks without such diversity.
We supervisors will consider furthermore all of the diversity-related aspects that are most relevant to enhancing the individual and collective leadership of boards. This means diversity of experiences and backgrounds in addition to gender diversity.
Individual leadership implies knowledge, skills and experience, of course. But first and foremost, it means the ability to listen and the ability to challenge. Executive board members must be open and sensitive to the views of the other members in a management body; they must be able to take decisions that may prove unpopular with stakeholders but that would definitely be good for the business of the bank. And non-executive board members must remain objective, constructively challenge the executives and be resolute when doing so.
All of these leadership qualities are essential, but they are also difficult for a supervisor to assess. Questionnaires and an interview are sometimes not sufficient for a supervisor to determine whether a specific candidate really is suitable for the leadership role a bank wants them to take. Banks are much better placed to make this assessment because they carry out the recruitment process and have access to a broader set of tools than the supervisors. It is the banks that are responsible for finding the right leaders for the right jobs and for ensuring that they are suitable at all times. European banking supervisors have a second line role – to check that there are no prudential grounds to question the bank’s decision.
Enhanced approach to FAP supervision
So, to help banks to be more effective in the selection process, we supervisors need to clarify our supervisory expectations and how we perform our role. For this reason we are working on an enhanced approach to fit and proper supervision. The aim of this enhanced approach is to make suitability assessments more efficient and enable better scrutiny of board members. We trust that this, in turn, will have a positive impact not only on the safety and soundness of individual banks but also on the wider banking sector. The approach entails a package of measures which aims to provide the right incentives to banks, most notably through three innovative elements I would now like to highlight.
First, we will encourage banks that are subject to an ex post assessment regime to provide us with their suitability assessments before making appointments. This will prevent a situation where a board member has already taken up his or her role but then needs to be removed because the ECB’s subsequent assessment was negative. The removal of an acting board member causes reputational risks that can easily be avoided. Early communication allows for a better exchange of views on the candidate’s characteristics and on how they would contribute to the collective diversity and skills of the board. It also complements the current regular supervisory dialogue with banks on envisaged appointments.
Second, when assessing the suitability of appointed and reappointed candidates, we are going to give greater consideration to supervisory findings related to previous positions of the candidates, if any, and the specific needs of the banks. The current approach only takes into account direct links between the specific role and responsibilities of a board member and the supervisory findings. Under the new approach, we will look more closely at all forms of personal involvement in the issue leading to the finding and, in particular, whether the candidate appropriately challenged any decisions that were taken. We want to underline that collective leadership and mutual challenge are vital to well-functioning boards. As regards the specific needs of any given bank, we will carefully look at how the appointee would contribute to the diversity policies in place at the bank in question.
Third, we are going to explain in more detail how we will reassess board members in the event that new material facts that could affect their suitability emerge after they have been appointed. In particular, as money laundering risks have become increasingly relevant for prudential supervision, in the revised Guide to fit and proper assessments we will explain how findings relating to money laundering are considered in FAP reassessments from a prudential perspective. This could involve close cooperation with the competent authorities for breaches related to anti-money laundering and countering the financing of terrorism, as provided for in the European framework.
Let me conclude. There is no unanimous view on what constitutes good leadership. My philosophical background and my supervisory experience lead me to believe that this is an additional argument for diversity: there is no single recipe for success, it has to be adapted to the individual situation of each bank and the challenges it faces.
This is why we want to provide the right incentives to enhance the ability of the management body to capture all the necessary perspectives and the ability of each board member to perform tasks with due diligence and integrity. Nominating board members is a great responsibility for banks because these leadership qualities cannot be confirmed with diplomas – they can only be proven by successful experience and good references. They also need to be tailored to the specific situation of each bank.
Our forthcoming revised Guide to fit and proper assessments should be understood as a tool to help banks select the right leaders. Before making appointments banks will have a much better idea of what the ECB expects from their nominees and what the outcome of their suitability applications could be. And we will maintain a continuous dialogue with the banks on how diversity will help them face the current challenges.