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The effectiveness of European banks’ boards: progress and shortcomings

Speech by Andrea Enria, Chair of the Supervisory Board of the ECB, at the Florence School of Banking and Finance online seminar “Banks’ Board Members and Policy Makers: A Conversation”

Frankfurt am Main, 28 May 2021

This speech was edited on 28 May 2021 17:42. Four factual changes were made in the fourth, fifth, sixth and the ninth paragraph, and the twelfth paragraph was added to reflect the speech's delivery.

Introduction

Thank you for inviting me to speak today and to take part in the conversation about the role that boards have to play in steering banks through the challenges ahead, be it those posed by the coronavirus (COVID-19) crisis or those that will remain thereafter. As food for thought before our conversation starts, I will also look at how banks’ internal governance has developed in recent years. In addition, I will highlight areas where improvements are still needed and discuss the supervisory tools that we will use to encourage banks to further improve the effectiveness of their boards.

Sound governance and strong internal controls are crucial for fostering responsible decision-making and mitigating the risks that banks face during normal times – and even more so in times of crisis. As part of our ongoing supervision, we encourage banks to have clearly established lines of responsibility, adequate risk management and effective controls, and checks and balances at every level of their organisation, starting at board level.

Boards of European banks: progress and shortcomings

As supervisors, we know that over the last few years, the boards of European banks have improved: they have become more effective, more mindful of their role, and more likely to challenge their executive management. The enhanced clarity that ECB Banking Supervision has provided in terms of how we expect boards to behave seems to have raised the bar on governance. Let me give you some examples.

Board members’ knowledge and experience is becoming more robust. The percentage of board members with more than five years’ experience in banking, finance and economics has increased over the last few years, and is now higher than 80%. We do not expect it to get much higher given the indisputable value of having a diversity of backgrounds at board level.

Board expertise is also expanding and becoming more diversified across new risk areas. In my view, it is particularly relevant that the number of non-executive board members with solid experience in IT almost doubled over the last years, from 13% in 2017 to 24% in 2020. This also reflects banks’ recent digitalisation efforts.

European banks are also making room on their boards for more formally independent members, with the proportion in relation to non-executive members increasing from around 50% in 2017 to almost 60% at the end of 2020. Experienced members who are independent and able to foster critical debate about strategic decisions and to challenge the executive board contribute directly towards increasing a bank’s resilience to challenges. At the same time, their involvement will help banks navigate the transformation that will ensue as our economies become more digital and we start to tackle the climate crisis.

Having an effective board is important at all times, but becomes absolutely critical in times of crisis, and banks seem to be aware of that. Since the start of the COVID-19 crisis, most banks have enhanced the interaction between senior management and their supervisory boards through the use of existing committees or by establishing new crisis committees to deal with the most pressing challenges. In this respect, good governance has also paid off: banks with strong governance have been quicker to reprioritise projects and make good use of teleworking and digital opportunities to adjust their strategy as required.

Shortcomings in board composition and oversight capacity

Unfortunately, and despite the progress observed, the oversight capacity of boards in most banks is still not strong enough. Although the proportion of formal independent board members has increased, they still make up only 15% of most boards. This has hampered the quality of debate regarding the executive decisions taken during the pandemic and may damage the quality of future decisions, not only on coronavirus-related topics, such as credit risk management and capital planning, but also on longer-term topics that will ultimately determine the sustainability of banks from a business perspective in the years to come, such as climate risk, their digitalisation strategy, or information technology and cyber risks.

Another area where progress can still be made is diversity in the composition of bank boards. Around a fifth of euro area banks have still not implemented a diversity policy, while those that have still have a long way to go in terms of implementing them fully. Furthermore, women still make up less than a third of non-executive directors and only a quarter of executive directors for SSM significant institutions.

With all the widely documented benefits that diverse boards bring to any organisation, this is a matter of concern, and one that we will continue to encourage progress on. In this context, the work being developed by the European Banking Authority to benchmark diversity policy practices and gender representation in the management bodies of European banks is also very important.

The revised guide to fit and proper assessments helps address the challenges ahead

To help address the shortcomings that remain and tackle the challenges ahead, ECB Banking Supervision has decided to upgrade its guide to fit and proper assessments and further clarify our expectations on the suitability of board members. We trust that this revised methodology will offer more support to banks in their internal recruitment processes and their assessment of board members.

This guide, on which we will launch a public consultation soon, details the policy stances, supervisory practices and processes applied by the ECB when assessing suitability of members of the management bodies of significant credit institutions. Within this remit, and although national laws apply to our assessments, the guide will enable us to increase the consistency and level playing field of our analysis and outcomes, which is crucial in this area of European banking supervision.

When looking at bank boards, we will devote more attention to assessing their diversity and their ability to deal with emerging risks. Regarding gender diversity, we are striving to make sure that existing national frameworks and internal rules for the enforcement of gender quotas are tackled as part of fit and proper assessments and ongoing supervision. Regarding climate risk, and in line with the guide published in November 2020, we will encourage banks to consider climate-specific skills and expertise when recruiting members for their boards.

Fit and proper supervision needs to be harmonised within the European Union

Notwithstanding the undeniable importance of boards and their composition in determining banks’ resilience – and ultimately their sustainability after a crisis like the COVID-19 one – fit and proper supervision is still one of the most fragmented topics in banking supervision. Divergent national approaches to the supervision of board member suitability make it difficult for the ECB to ensure a level playing field within its supervisory remit.

In this context, we would very much like to see a further push for harmonisation in this area in the next legislative package. For example, the timing of the fit and proper assessment should be the same in all banking union countries, i.e. before the candidate takes up the position. The same should be true for the assessment of the heads of internal control functions. We would also like to see a reinforcement of banks’ responsibility for implementing adequate internal suitability policies and processes at group level.

Conclusion

In conclusion, thanks to our revised approach to fit and proper supervision, we are strengthening our call for diverse and experienced board members who can effectively oversee the executive management function and promote a culture whereby board members constructively challenge each other on issues that will arise in the context of the COVID-19 crisis and in the longer term in relation to climate and environmental risks, business model sustainability and digitalisation strategies.

As always, the dialogue between bank non-executive directors and supervisors is also key to ensuring mutual understanding and expectations. I now look forward to today’s conversation.

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