Bank Governance Best Practices: Optimizing Your Board of Directors

In today’s turbulent banking environment, the importance of effective bank governance has arguably never been more important. Banks currently face an arsenal of risks, some of them longstanding and others relatively new to the scene. Bank boards play a critical role in monitoring these risks and monitoring bank management, who is ultimately responsible for overseeing the day-to-day management of these risks. In July 2023, Bank Director published its 2023 Governance Best Practices Survey. This survey included responses from 195 independent directors, chairs, and chief executives of US banks below $100 billion in assets. The survey was conducted in April and May 2023. In this article, we share three of our key takeaways.

Board of directors' composition—board members and expertise 

Board composition is integral to the effectiveness of any board. Given the various risks faced by banks, it is essential that boards include board members with diverse experience. Electing board members with expertise in all facets of your bank, such as accounting, risk management, compliance, and information technology, will help ensure that conversations between board members and management are robust and meaningful. Having board members with diversified backgrounds and experience will allow them to respectfully challenge management’s initiatives and strategies, which will only serve to strengthen these initiatives and strategies. These board members will also become a resource for management. A board member who knows the ins and outs of a specific banking function, for instance, information technology, gives management confidence in the board’s oversight and provides management a resource to contact when the need arises.

The survey found that boards are generally well covered when it comes to having board members with finance and accounting experience. Specifically, 95% of respondents had finance and accounting experience. The finances and accounting of a bank have long been focal points of discussion in board rooms and ineffective financial management and/or inappropriate accounting methods can be detrimental. Thus, it is reassuring that so many respondents had finance and accounting experience, especially with such a monumental accounting change upon us: the current expected credit loss (CECL) standard.

However, a relatively newly heightened focus for banks, cybersecurity, did not see as robust a result: only 33% of respondents had cybersecurity expertise. With the vast amounts of data held by banks, institutions are a prime target for hackers. Furthermore, the avenues in which an attack can occur are nearly infinite. Cybersecurity is not glamorous. In other words, bank management would likely prefer to allocate resources toward other, more strategic initiatives, such as digital banking, new branches, new products, etc. This is even more reason to have a board member with cybersecurity experience. It is this individual who will fully understand cybersecurity’s importance and the risk that even a single cybersecurity incident could pose to the bank. 

Board of directors’ composition—board members and tenure 

53% of survey respondents indicated they have one or two directors who are 55 or younger, implying the remainder of the directors are over the age of 55. 33% indicated they have three or more directors who are 55 or younger, and 14% indicated they don’t have any directors who are 55 or younger. The current interest rate environment is one that many younger management teams have not seen in their professional lifetimes. However, the US prime rate, a proxy for overall interest rates, hit a record high in December 1980 of 21.50%. More experienced board members could be an invaluable resource to management teams in navigating this environment, as they have the ability to share practical solutions that may have been implemented during the high interest rate environment seen in the late 1970s through the 1990s. Even in June 2006 the US prime rate hit  8.25%.

While having longer tenured board members is important, having younger board members is equally as important, especially given the fast-changing operating environment. Digital banking is not a “nice-to-have” anymore—it is a must have. And the digital banking space is evolving quickly, with new technologies, platforms, and vendors popping up frequently. It is a lot of information to sift through. But younger board members, who may have grown up with these technologies and use them on a day-to-day basis, generally are better equipped to advise on digital strategy. It is these board members that generally have the ability to understand the bank’s customer from a digital perspective.

Asset/liability management

Asset/liability management (ALM) at banks has been a hot topic ever since the onset of the COVID-19 pandemic. Although ALM is always seen as a crucial task, even during stable times, it has taken on an increasing level of importance given the rollercoaster ride that balance sheets and income statements have experienced over the past few years. Significant deposit growth resulted in substantial excess liquidity, followed by tightening liquidity and surging unrealized losses as a result of rising interest rates. It has been a whirlwind for those in charge of ALM. Bank boards have effectively responded: 83% of respondents noted their board or relevant committee has revisited the bank’s ALM policies, processes, and programs within the past 6 to 12 months. Regardless of recent whirlwinds, it is likely best practice for bank boards to revisit ALM policies, processes, and programs on at least an annual basis. Some questions to consider on an annual basis are:

• Do our thresholds and ranges still make sense given the current economic environment?
• How does our ALM policy tie into the bank’s larger strategic plan? Do they complement one another or are they contradictory? If the latter, is our strategic plan unreasonable or does our ALM policy need to change?
• Who is in charge of monitoring ALM on a day-to-day basis? Is it one individual or a team?
• What types of information are being reported to the ALM committee? How about to the board? What is the frequency of communication?
• Are there new products that have been implemented or that are being considered? How could these products impact ALM?
• What impact has digital banking had on ALM? How about branch openings or closures?

Bank boards play an invaluable role in overseeing and monitoring the operations and risks of a bank. If the right individuals are put in place, a board can almost feel as if it is an extension of a bank’s management team, serving as a resource well beyond the board room. Although implementing ALM discussions into board conversations can happen immediately, our other key takeaways, namely board expertise and tenure, cannot change overnight. But as the Chinese proverb goes: “The best time to plant a tree was 20 years ago. The second-best time is now.” As board members either retire or term out, now may be the time to rethink your board recruiting strategy. Think about your bank’s strategic plan and consider if there are gaps in your board in the context of your strategic plan. If there are, what causes these gaps? Asking these questions will allow you to be more strategic in your board recruiting efforts, ultimately maximizing the effectiveness of your board in light of your institution’s intended strategy.