G30 Calls for New Paradigm for Bank Supervisors and Boards of Directors

It is a great pleasure to once again present a Group of Thirty (G30) report to the press.  The G30 is composed of international former and current financial officials and leaders from academia and financial institutions. The views that we express in our reports reflect the views of the working groups and their members. Our focus is always on issues that we consider important for strengthening global economic stability and the resilience of the financial system.  

 

Ever since the financial crisis we have made it a priority to consider how the fundamental safety and soundness of our financial institutions can be strengthened. Our work has drawn on input from our members and scores of other leaders of finance in both the public and private sectors. A paramount conclusion that we reached some time ago was that not enough has been done since the crisis to strengthen confidence. We view many of the new rules and regulations that have been determined as essential. But, they alone will not restore trust in the system to acceptable levels.   

 

We addressed this issue in April of last year when we published our report called Toward Effective Governance of Financial Institutions.  Among the responses to our recommendations at that time was a very constructive exchange of perspectives with members of the Financial Stability Board, who encouraged us to pursue the work that we publish today in our new report titled A New Paradigm: Financial Institution Boards and Supervisors.  

 

We propose a new paradigm between bank supervisors and the boards of banks. Trust in bank governance has been eroded and it needs urgent repair. That means more effective supervision. Banks and financial institutions should not resist this reset in relations. Instead they should work to make the new paradigm work to their mutual benefit.    

 

Why a new paradigm? Because the current one is not working. Exchanges of candid and detailed views between supervisors and board directors, which could have a profoundly beneficial impact on the ways banks are run, are not in many cases taking place. This needs to change.  

 

Experience since the financial crisis shows that new banking rules and regulations are not sufficient. The exercise of judgment by banking supervisors, coupled with more active leadership by bank boards of directors is essential to good governance. Achievement of effective supervisory outcomes will depend on the establishment of better relationships of mutual trust between supervisors and boards. 

 

The G30 steering committee, supported by many G30 members, is now presenting detailed recommendations for improvement. We have concluded that the changes that are needed are substantial and numerous and therefore a new paradigm is in fact what is now necessary.   Now, let me turn to my steering committee colleagues to introduce the report. First our chairman, Roger Ferguson in New York. 

Thank you Jean-Claude, and welcome to all of you from those of us here in New York.  

 

First, I want to thank Project Director Nicholas Le Pan for his outstanding work and contributions to the report, along with the project team from Oliver Wyman, especially James Wiener, Davide Taliente, and Dominik Treeck. This report would not have been possible without them.   

 

As Jean-Claude said, our report calls for a new paradigm in the way boards and supervisors of major financial institutions interact. We believe that boards and supervisors must make a long-term commitment to building and sustaining closer, trust-based relations founded on open communication.  

 

We do not underestimate the difficulty in attaining this goal – it will require major changes in approach for each party – but we see it as essential to improving the safety and soundness of major financial institutions and restoring public trust.  

 

We believe that supervisors and boards need better ways to assess strategies and risks, governance, and corporate culture. New regulations alone are not enough to achieve this goal. Rather, there must be a substantial, qualitative enhancement in their interaction.  

 

I want to stress that our recommendations in no way diminish the importance of management’s regular and frequent interaction with supervisors. Indeed, our report underscores the need for a vibrant triangular relationship between supervisors, boards and management.    

 

We believe that governments must carefully review how they support the supervisory function. In many cases, supervisors are not accorded the stature and independence they need to do their work well.  Better training is needed. Where compensation is insufficient to attract and retain the best people  for supervisory roles, more resources should be found. 

  

At the same time, boards should also review their standards and processes. They must have the right people – people with the expertise to engage in detailed discussions with supervisors about the complicated issues around risk management, as well as corporate culture. Board directors in many cases will find they need to further build their expertise.   

 

It’s important to note that we are not suggesting a partnership between supervisors and boards. There has to be a clear divide. Rather, we are proposing more robust and continuous dialogue. This requires that boards and supervisors have a greater understanding and respect for each other’s duties, powers, responsibilities and authorities. They must exchange information sufficiently to prevent sudden surprises. They must engage in dialogues that go well beyond stress test findings and compliance with regulations.  

 

The proposals we are making are pragmatic. And a new paradigm is essential. We are concerned that in its absence, trust in the financial system will continue to be weak.  

 

Now, my steering committee colleagues will provide some further insights. Let me start here in New York with Bill Rhodes. 

 

 

Thank you. On presenting our last report I stressed how important reputational risk is to banks and this goes to the heart of culture. A deficiency or failure of culture including reputational risk can be as destabilizing to an institution as problems of capital or liquidity.  Considering culture together with governance and business strategy is an essential part of forward-looking supervision.     

 

Far too little attention has been paid to reforming culture in many institutions. Every bank has its own culture. Boards and supervisors must better understand cultural factors in effective governance.   

 

Culture is about behavior. It is about how individuals and groups act even when they are not being observed. A good culture underpins and is reflected by the actions of a company’s employees, A problematic culture will also be reflected in how a firm and its employees perform. Making judgments on culture is subtle, complex, but essential and needs to be elevated in discussions between supervisors and boards.”  

 

Too little attention has been paid to reforming culture in many institutions. Boards must be proactive in understanding the culture of their organization and how that translates and supports their business model.    

 

A culture that places too great an emphasis on profit-maximization and risk is one that can damage the financial strengths and the reputation of the bank – and once a reputation is lost, it is incredibly difficult to restore it.  

 

Supervisors should be prepared to share their observations about an institution’s risk culture with the board. Supervisors should be alert for serious culture issues that raise alarm and need correction.  But because this is such a complex issue supervisors and policy makers should be cautious about writing rules or guidance about culture, and they should set realistic expectations about what they can achieve.   

 

 We are proposing that boards should identify and deal seriously with risky culture, make sure their compensation system in practice supports the desired culture, and monitor risk culture. Supervisors should share their observations about the institution’s risk culture with the board, and should look out for serious culture issues that need rectification.    

 

Thank you. Let me now turn to John Heimann to discuss the role of supervision in more 

detail. 

 Thank you Bill.  As a former supervisor I want to just make a couple of comments to emphasize some of the perspectives in this report.   

 

We have concerns, which reflect the views of many G30 members and the many experts that were interviewed for this study, that many governments do not sufficiently recognize the key roles that supervisors play, or accord them the stature that they need.   

 

They need to be independent of political interference. They need to have the stature that assures them respect from directors on bank boards and from top public officials. This demands strengthening training in many countries. It also means that they need to be paid well.   

I can see some of you perhaps saying that this just escalates further public spending on regulating and monitoring the banks. Yes, it does. But we argue in our report that these added costs are small compared to the costs of financial crisis.  

 

The essential message is that supervision is much more than checking compliance with rules and regulations.  It is making judgments about the risks inherent in institutions, about the quality of their management and governance systems, about intervening if necessary to achieve results.   Enhanced stature for the job of supervision is needed and will contribute to effective engagement with global banking organizations at the most senior levels and to the ability to attract and retain staff. We are clear that high-quality supervision is a lot less expensive than a financial crisis.  

 

As you read this report you will see that the judgments that supervisors have to make are very challenging. There are often no clear right or wrong answers. Many of the issues in regard, for example, to corporate culture demand depth of exchanges with managements and board directors that can enable case-by-case advice. 

 

Of course, to be effective, the supervisors need to have the right counterparts on bank boards. So now let me turn to Sir David in London.   

 Thank you. The new paradigm demands commitments from boards of directors that I think many boards are already considering, but clearly there needs to me more work.   

 

 Many boards are being forced to rethink the ways they operate, not only relative to managements and shareholders, but also relative to supervisors. The composition of boards is noted in the new report, because there has to be a range of expertise present and a willingness by directors to put in more time. In fact, the report today stresses that there is no way around greater time commitment for many directors in many institutions. We believe the pay-off will be significant.   

 

 Many board directors do not have an adequate understanding of what supervisors are meant to do, over and above ensuring compliance with the rules and regulations. The issue of judgment that John Heimann has just mentioned is absolutely central to the kinds of discussions that we in the G30 are now advocating.   

 

“Supervisors need to be better informed. They must make judgments on whether boards are doing an effective job and when necessary supervisors must initiate remedial action.  For their part, boards can benefit from the insights that supervisors have about the institution itself, governance trends and peer comparisons.”    

 

 I do not think that entrenching this new paradigm is going to be easy. Building trust between boards and supervisors is going to take time.   

 

For this new paradigm to work boards at many banks need to be proactive and take supervisory relations more seriously.  Boards need to be open to supervisors so supervisors can do their job.  Boards need to focus on risk culture.  Boards also need to be adequately resourced and to include members with the right mix of skills and experience. More time commitment by certain board members is inevitable.  But the potential pay-off is large.  

  

 The report provides a good deal of detail of how relationships should be developed and what the demands are on both sides. I believe that the recommendations are important for the soundness of our financial institutions.