According to the latest paper on governance from the Basel Committee, “Board members have responsibilities to the bank’s overall interests, regardless of who appoints them.” What does this mean? What are the bank’s “overall interests”? Board members are elected by the shareholders and are there to represent their interests – right? This statement seems to suggest that the authors believe there will be situations where the “overall interests” and shareholders’ interests diverge.
Overall interests cover a number of stakeholders: depositors, wholesale funders, borrowers, shareholders, employees, clients, and regulators (representing the broader financial system). In the past, Boards represented the shareholder’s interests first and foremost; however any bank with a view to remaining profitable (and viable) in the long term needed to balance other interests. Trust and brand are important commodities in banking.
I am curious as to how this changes the lens with which Boards consider things such as innovating vs not innovating, the level of risk tolerance, and expansion into other business areas. Examples of where the conflict between stakeholders could occur are:
- Carrying on with the current systems vs making a core system upgrade is an example. The first action does not need any major spending but requires the bank to continue with patches and manual workarounds while the latter could cost billions of dollars. The investment will tie up the balance sheet and reduce cash for distribution, but in the long term lowers operational and strategic risk. Operational risk is reduced by a lower likelihood of processing errors and strategic risk is reduced as the bank can integrate into digital channels if required.
- The Board of a banking subsidiary could have conflicts with the parent company who is the sole shareholder. Many of the Board members may be senior executives of the parent company.
- Does the bank expand into a new area such as wealth management? This could be good for shareholders e.g. through diversification, synergies and better product packaging and cross-sell. But is there any benefit for current lending and deposit customers?
- Can the Board rely on only share price metrics (e.g. TSR) in the executive compensation formulae? And how best to incentivise your senior management team to maximise the “overall interests”?
At the moment this is just a set of draft guidelines. Further clarity is needed from either BCBS or from regulators who may eventually adopt these principles. This document puts directors on notice. They have a role beyond just representing their shareholders. Boards may need to think about how they ensure that senior management and the organisation in general are acting in the overall interests.