On April 5, 2016, the FDIC released a Special Corporate Governance Edition of Supervisory Insights. This "SCG Edition," which is directed primarily to community banks, offers commentary on the FDIC's Pocket Guide for Directors and other guidance related to corporate governance and strategic planning. In this context, the term "community bank" does not refer to banks below a particular asset-size cutoff, but refers instead to those whose business models reflect a focus on traditional lending and deposit-gathering activities within a fairly limited geography.
The SCG Edition is not intended as supervisory guidance, nor does it constitute a revision of the Pocket Guide for Directors. Instead, like other articles published in Supervisory Insights, it is designed to provide helpful information and resources to assist community bank directors to better navigate their roles and responsibilities. In this current edition, that includes a list of resources with links to regulations, as well as guidance and training materials.
After a brief introduction, the SCG Edition devotes sections to a discussion of community bank corporate governance, an expanded commentary on the FDIC's Pocket Guide, and a discussion of factors that impact FDIC examiners' assessments of community bank board effectiveness. The relative brevity of the document and the presence of white space on nearly every page invite thorough reading, and the use of frequent section headings and text boxes allows for easy review of topics that may be of special interest.
Community Bank Corporate Governance. The SCG Edition acknowledges that the concept of corporate governance has no single definition. But it uses the term as the FDIC's convenient, shorthand reference to a community bank's relationships, policies, and processes that provide strategic direction and controls.
The emphasis in the section devoted to corporate governance is primarily on a community bank's board of directors, but also includes discussions of the extent to which effective corporate governance requires significant cooperation between a community bank's board and senior management. This cooperation is perhaps most evident in the nexus between a board's establishment of a clear governance framework (including sound objectives, policies, and risk limits) and its responsibility to monitor the extent to which officers and employees comply with that framework.
It should be generally understood that effective board oversight involves the directors sending a clear message to staff that they value a strong risk management culture that includes a strong ethical culture. A risk management culture is described as a series of interrelated characteristics of the bank that influence risk decisions. These may include such things as objectives, policies, controls, values, and behaviors -- each of which is responsive to board leadership. A strong ethical culture is characterized by a belief that the interests of customers, investors, the community, and other stakeholders take precedence over short-term profits. Specific guidance regarding the latter is provided in the FDIC's Guidance on Implementing an Effective Ethics Program, which presents what amounts to an annotated checklist of components of a code of conduct or ethics policy. That guidance is available as an attachment to the FDIC's Financial Institution Letter FIL-105-2005. (See link below.)
Commentary on the FDIC's Pocket Guide for Directors. We presume that readers are familiar with the FDIC's Pocket Guide for Directors, a 1,250 word document that remains unchanged since it was issued in 1988. The SCG Edition expands upon the six major topics in the Pocket Guide (e.g., maintain independence, keep informed, supervise management, etc.), but our objective here does not include an item-by-item recitation of the FDIC's commentary on those topics. In light of the importance of risk management, we'll address instead the often-invoked sliding scale that modulates the application of some regulatory requirements. That sliding scale generally incorporates one or more variations of the phrase, "appropriate for the size, complexity, and risk profile of the bank."
The SCG Edition implies that a proper foundation from which the board may set appropriate business objectives, properly monitor the bank's operations, and supervise senior management, involves a solid understanding of the bank's risk profile. According to the FDIC, this understanding requires more than an evaluation of the bank's current financial condition. It may begin from there, but must also include an assessment of the riskiness of the business model.
That additional factor includes (i) an understanding of the types of products and services the bank offers and how those products and services are delivered; (ii) an evaluation of how the bank manages the risks associated with its business model and growth plans; and (iii) an awareness and consideration of developments outside the bank, i.e., potential external threats from the bank's operating environment. When the sliding scale concept of the complexity, nature, scope, and risk of a bank's activities is invoked to describe how rules or guidance should be applied, it refers to this type of risk profile assessment.
Examiners' Assessments of Community Bank Board Effectiveness. Studies of failed banks and troubled banks identify ineffective leadership and oversight by directors and senior management as a significant causal factor. That by itself is sufficient reason for FDIC examiners to carefully assess an institution's corporate governance framework at each onsite examination. The results of that assessment are incorporated into the "Management" component of the CAMELS rating.
The SCG Edition identifies a dozen elements that factor into the Management component review, and expressly states that those elements do not exhaust the list. Any attempt to rank order the factors would constitute an exercise in missing the point. Each is an important element in a well managed institution, but we would not question the placement of oversight by the board of directors and senior management at the top of the list. That element may deserve the top slot. But we mention it here because it is relevant to the concluding section of the SCG Edition, which presents a partial list of conditions whose presence at a community bank would lead the FDIC to expect a higher level of board oversight.
The appropriate level of board oversight will vary from one institution to another and must vary at any single institution in response to changes in the nature and complexity of the bank's operations and in response to external factors. A CAMELS composite or component rating of 3, 4 or 5 and/or the existence of a regulatory enforcement action would be an obvious wake-up call to a bank's board. But other conditions may develop more slowly, and may therefore fail to prompt a timely increase of board oversight. These conditions include, but are not limited to:
- elevated asset or funding concentrations;
- rapidly shifting balance sheet structure;
- low or shrinking levels of liquid assets;
- low capital levels or poor access to new capital;
- deterioration in local economies or in business line fundamentals; and/or
- plans to change the business model or enter into significant new lines of business.
Those are just a sample of conditions that should attract directors' early attention and should motivate serious consideration of increased board oversight.
The Special Corporate Governance Edition of Supervisory Insights is on the FDIC's web site. It is available through this link:
The Pocket Guide for Directors is also available on the FDIC's web site through this link: https://www.fdic.gov/regulations/resources/director/pocket/.
Financial Institution Letter FIL-105-2--5 is available on the FDIC's web site through this link: https://www.fdic.gov/news/news/financial/2005/fil10505.html.
James T. Bork, J.D., LL.M., is Senior Banking Compliance Analyst with Wolters Kluwer Financial Services. Prior to joining WKFS, he practiced law for several years with a focus on financial institutions, consumer banking issues, commercial lending, and business law. He was also Assistant General Counsel and Senior Compliance Attorney at a billion dollar institution. Jim has written articles and spoken on regulatory and compliance developments affecting financial institutions. He received his law degree in 1989 and earned a Master of Laws degree (LL.M.) in banking law in 1993 from the Morin Center for Banking and Financial Law at Boston University School of Law.
