Supervisory Boards invisible members

As for management boards, it is vital for banks' supervisory boards to be fit for the future. European banking authorities are increasingly focused on the composition, tasks and operations of supervisory boards. It is essential for banks' supervisory boards, to ensure they understand supervisory expectations and to pro-actively address any weaknesses - sooner rather than later.

In March's ECB Office Quarterly Newsletter we wrote about the rapid evolution of European banks' managing bodies. In particular, we highlighted the need for management boards to respond to changes in regulation, technology, capital markets and corporate governance.

But it's not only management boards that need to be fit for the future. Banks' supervisory boards must also adapt to a fast-changing world and ensure they have the expertise to oversee the activities of senior managers. This increased responsibility is accompanied with higher accountability and scrutiny from supervisors who are paying close attention to the roles of supervisory boards in maintaining a healthy banking union. It's well known that supervisory boards - or non-executive directors, for banks with unitary boards - have a duty to represent the interests of stakeholders such as shareholders, employees and, in the case of public banks, taxpayers. What is often less widely appreciated is that external supervisors also hold an `invisible seat' as observers on a bank's supervisory board.

These `invisible' members view the composition and activity of boards as essential for a bank's stability. And though they may not usually be physically present at the table, there is no doubt about their indirect influence and increasing interest in supervisory boards. For instance, they assess the individual skills and suitability of board members in a more structured and formalised way.

Furthermore, supervisory expectations are evolving rapidly. European authorities continue to clarify and harmonise their individual and collective criteria for board members, as well as the ways in which supervisors should apply those standards. The most important requirements are set out in:

The ECB's supervisory statement on governance and risk appetite in the SSM (PDF 457 KB) (June 2016)
The ECB's Guide to fit and proper assessments (PDF 412 KB) (May 2018)
The EBA's Guidelines on internal governance under Directive 2013/36/EU (PDF 799 KB) (September 2017)
The EBA and ESMA Guidance to assess the suitability of management body members and key function holders (PDF 1.10 MB) (September 2017)

Of course, it remains to be seen exactly how some of these requirements will be implemented. For example, the desire to achieve consistency across the SSM will need to be balanced against national variations in corporate governance. But we have no doubt that the collective suitability of boards will continue to move up the agenda during the SREP and other day-to-day supervision. We also expect the ECB to increase peer benchmarking of supervisory boards.

In our view, it is therefore essential for supervisory boards to ensure that they understand European authorities' expectations. We summarise these under three key headings, as follows.

1. The composition of supervisory boards. Recent years have seen remarkable changes in banks' operating environment. Some of the most obvious developments include:

More demanding requirements for compliance, governance and risk management; and
o The impact of digitisation in areas such as data analysis, customer experience, product development and external communications.
The impact of a demanding economic environment, in some countries it is the high stock of NPL, in others traditional business models are under pressure not only because of bank challengers but also the interest rate environment.

In short, banks face a dual challenge to upgrade infrastructure while increasing profitability. This means that supervisory boards need more skills, experience and time than ever to carry out their responsibilities effectively. Supervisory boards nowadays need to show not only that individual board members understand the business and the wider banking system, but also that each member contributes to the collective knowledge and experience and the supervisory board as a whole meets the requirements of the EBA and ECB.

2. The tasks of supervisory boards. The EBA's Guidelines on internal governance make it clear that the key mission of supervisory boards is to monitor and challenge strategic choices and the way in which those decisions are implemented. Based on observations from SREP 2017 and the ECB's priorities for 2018, we believe the most important tasks for supervisory boards are:

To ensure internal governance is effective, with a particular focus on the compliance and internal audit functions;
To monitor the implementation of strategy, with a particular focus on strategic objectives, organisational structure and risk strategy; and
To ensure the integrity of internal controls, financial information and risk reporting.

3. The operations of supervisory boards. The requirements of the EBA and ECB consistently stress the need for supervisory boards to constructively challenge executive management. For this to be possible, supervisory boards will need:

Full access to information with proactive support from internal audit and compliance functions as well as from audit, risk, nomination and remuneration committees;
Sufficient time for open and critical discussions; and
Ability and strength of each supervisory board member to ask uncomfortable questions.

Once they are familiar with these requirements, it is equally important for supervisory boards to critically review their current board expertise, and to address any shortcomings as soon as possible. In doing so, they should realise that supervisors' increased requirements could make it harder to recruit suitably qualified board members in future. The need to appoint more specialists could also lead to other problems, such as decision-making difficulties that can be a feature of excessively large boards.

Accordingly, banks should consider three important steps to support the development of a sound supervisory board:

Balance the collective knowledge of the supervisory board with its size and establishing a long-term view on succession planning;
Maintain continuing training programmes for individual supervisory board members; and
Support board members as they prepare for supervisory interviews.

In conclusion, we would strongly advise supervisory boards not to underestimate the growing expectations, or the increasing importance that European and national authorities attach to this area. As we have said before, action is better than inaction. Taking a `wait and see' approach to building the supervisory board of the future could carry significant risk of losing influence. Using more of its power might therefore become more likely for supervisory boards of SSM-banks going forward.