BREAKINGVIEWS-Fading crisis should galvanize bank boards

— The author is a Reuters Breakingviews columnist. The
opinions expressed are his own —

By Richard Beales

NEW YORK, Feb 8 (Reuters Breakingviews) – Bank regulators
haven’t exactly covered themselves in glory. But an earlier
defense against bank excesses ought to be their boards. It’s
not an easy job, but directors could try harder to control
risk-taking. Uncomfortable questions are welcome.

One worth repeating, with the financial crisis slowly
fading and 2009 results heralding a possible return to
normality for some U.S. and European banks: “Why are we doing
so well?”

Boards often discuss problems. But from the UK’s Northern
Rock to Countrywide in the United States, greater scrutiny of
fast-growing and highly profitable businesses might have
revealed weakening standards and optimistic assumptions.

Or how about this: “What could make this institution fail?”
Bank bosses should know broadly how the economy, interest rates
and the like affect their business. But when the U.S.
government ran stress tests last year, it found that an
improbably high proportion of banks believed themselves more
resilient than average.

One way to pinpoint a bank’s vulnerability — whether to a
single financial asset class, counterparty or type of funding
— would be to turn the stress test on its head and identify
any icebergs that could sink it. Done right, that approach
might have highlighted American International Group’s (AIG.N: )
credit insurance portfolio — and perhaps its related and
circular dependence on its credit rating.

Part-time board members can’t be expected to grasp all the
ins and outs themselves. But they need to satisfy themselves
the person in charge knows how the bank makes money and where
its vulnerabilities are. Successive CEOs at AIG seem to have
been oblivious to its Achilles’ heel. Directors also need to
ask similar questions of risk managers and other employees when
CEOs aren’t present.

Of course, all this is famously difficult. CEOs — who also
often chair their boards, especially in the United States —
can outmaneuver even highly qualified and dedicated shareholder
representatives. And outside directors who ask too many tough
questions soon aren’t invited back. Still, for the sake of
shareholders, directors need to be as critical as possible.
Maybe they need a nudge from regulators. More vigilant boards
would save the watchdogs trouble.

CONTEXT NEWS

— Sir David Walker produced a report on UK bank governance
last year, releasing final recommendations in November. The
report’s conclusions centered on greater shareholder and board
engagement, including the idea that boards should challenge
management proposals. “The essential ‘challenge’ step in the
sequence appears to have been missed in many board situations,”
the report said.

— A report by Nestor Advisors on governance at 25 European
banks concluded in May last year that most bank boards had
failed in three broad areas in the run-up to the recent crisis:
“The focus on risk measurement at the expense of risk
identification; the failure to check excessive leverage; and
the gross underestimation of liquidity risks.”

— Walker review: http://r.reuters.com/fef48h

— Nestor study summary: http://r.reuters.com/gef48h

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— For previous columns by the author, Reuters customers
can click on [BEALES/]

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(Editing by Jeffrey Goldfarb and Martin Langfield)

BREAKINGVIEWS-Fading crisis should galvanize bank boards