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Board Training: "It’s Never Too Late"
Thursday, September 28, 2023

The role of a bank’s board of directors in the profitable, safe and sound operation of a bank is crucial. The board, while it depends upon management to run a commercial bank’s day-to-day operations, is ultimately responsible for a bank’s success (and also for answers to the regulators). What is essential for the role of the board is to provide oversight of management, assist in generating business, enhance the profitability of the bank’s business to please customers, satisfy board duties to stockholders, and last, but by no means least, to make sure the bank is operated in compliance with banking regulations.

As stated, the board is ultimately responsible for the safe and sound operation of the bank — i.e., compliance with all banking law. Among other things, a bank director must be aware of, and sensitive to, the particular risks of the bank. Those risks include:

  • Credit
  • Interest rate
  • Liquidity
  • Price
  • Foreign exchange
  • Transaction
  • Compliance
  • Strategic
  • Reputation

The last risk noted above, “reputation,” is vital but often hard to satisfy from a regulatory point of view, because pleasing stockholders with a bank’s operations so that the value of a stockholder’s investment may be enhanced may not always meet the reputation requirement, especially if “safety and soundness” is an issue. The Office of the Comptroller of the Currency has stated the following for national banks (but which applies practically to state chartered banks as well) that “although the board may depend on management’s expertise to run daily operations, the board remains ultimately responsible for monitoring the bank’s operations and levels of risk.”

The late John Horne, a native Alabamian and once Chairman of the Federal Home Loan Bank Board, in testimony before the House Committee on Banking and Currency in 1966 set forth a definitive explanation of what a safe and sound operation of a bank means. He stated in part:

The concept of “unsafe or unsound practices” is one of general application which touches upon the entire field of the operations of a financial institution. . . . Contributing to the difficulty of framing a comprehensive definition is the fact that particular activity not necessarily unsafe or unsound in every instance may be so when considered in the light of all relevant facts. . . .

Generally speaking, an “unsafe or unsound practice” embraces any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or . . . the insurance funds.

In 1981 the United States Court of Appeals for the Fifth Circuit in an opinion concluded that Mr. Horne’s statement is the “authoritative definition” of unsafe and unsound practices, and the Comptroller of the Currency stated in 2014 that it as well as other banking agencies have relied on Mr. Horne’s view in bringing enforcement actions in the decades since then.

There are many ways a bank’s board of directors may oversee the safe and sound operation of a bank in the light of relevant facts. A director’s own business and educational background can lay the framework for a director’s board duties. A director’s attention to the specifics of how management conducts daily operations includes a director’s ability (i) to ask questions at the board meeting, (ii) to avoid being a “rubber stamp” for management, and (iii) to bring ideas and questions to the board meeting based upon a review of what is to be considered at the meeting. All of those help the director satisfy proper bank director duties. One important (and often overlooked) avenue, however, upon which a bank director should frequently travel is based on training and continuing education.

It is true that for new banks in organization prospective directors must undergo director training to meet regulatory requirements. Also, if an existing bank is undergoing problems, the regulators may very well require director training on certain subjects that may be at the center of regulatory concerns. We have undertaken training in both circumstances. But what about existing banks that are otherwise healthy? Just because the bank is healthy does not mean director education is complete. It is always good for the profitable and safe and sound operation of a bank for the board of directors to have a director education policy in place. Education topics can range over a wide variety of issues such as (i) the particular risks faced by any bank, as outlined above, (ii) updates on regulations, (iii) current trends in banking generally (such as the recent increases in interest rates), (iv) recent bank failures (if any) and whether the factors leading to those failures could be present in the director’s own bank, and, finally (v) a periodic review of essential “red flags” that a bank at any time might experience. Those red flags include:

  • Capital ratios that fall below “well capitalized” or what is required by regulatory orders;
  • Poor performance in relation to peers — ROAA, ROE, NIM, Problem Asset Ratios;
  • High CRE/ADC ratios;
  • Failure to correct problems noted in the exam report or approval orders;
  • Compensation structure that encourages loan origination rather than loan performance; and
  • Regulation O and Regulation W violations.

Continued director education should be promoted by all bank boards. There are many ways a bank director, even an experienced director in a well-run bank, can learn of new developments and welcome a review of long-standing director duties. State bankers associations are excellent at providing director education both at annual conventions, special director training conferences, and often remote programs. Accounting firms, investment bankers and law firms also provide seminars for single banks to discuss current regulatory issues, director duties in general, or to address specific issues deemed important by the bank in question.

Banks and their directors should keep the importance of director education in mind and look for ways to “stay ahead” of issues (both good and bad) that banks may experience. As John Horne emphasized, a “particular activity” not necessarily unsafe or unsound generally might “be so when considered in light of all relevant facts.” It is crucial for a bank director to operate under that light.

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