The Fed giveth and the Fed taketh away.
Back in June, the Federal Reserve handed financial institutions fresh challenges by raising its benchmark federal funds rate for the second time in the calendar year. In August, the regulatory body fielded a pair of proposals that could remove some complexities and ease regulations for boards of directors of large financial institutions.
In its invitations for public comment, the Fed outlined its proposed changes, which would affect financial institutions with holdings of $50 billion or more. These changes would include:
- Clarify the supervisory role the Fed expects boards to play, and distinguish the supervisory responsibilities of boards from those of senior management.
- Identify five key attributes of effective boards to be used when assessing a board’s performance.
- Introduce a Large Financial Institution (LFI) rating system that would evaluate financial institutions based on their governance and controls, capital planning and positions, and liquidity risk management and positions.
- Remove from boards the responsibility to oversee MRIAs (Matters Requiring Immediate Attention) and MRAs (Matters Requiring Attention) and shift it back onto senior management to take appropriate action. This rule would apply to all financial institutions, regardless of their size. Boards would still be responsible for supervising senior management.
The proposal also sets forth five principles of effective board function:
- Set clear, aligned and consistent direction regarding strategy and risk tolerance.
- Actively manage information flow and board discussions.
- Hold senior management accountable.
- Support independent risk management and internal audit.
- Maintain an effective, capable board composition and structure of governance.
“These five attributes support safety and soundness and would provide the framework with which the Federal Reserve proposes to assess a firm’s board of directors under the proposed LFI rating system,” the Fed says.
Why the Fed has proposed the changes
In its proposal, the Fed explains that it is positing these changes on the heels of a “multi-year review … of practices of boards of directors.”
“The review assessed, among other things, the factors that make boards effective, the challenges boards face, and how boards influence the safety and soundness of their firms and promote compliance with laws and regulations,” the Fed says. Several issues emerged from the review, including:
- The supervisory roles of boards and senior managers have become blurred.
- Boards spend too much time on supervisory matters that “do not directly relate to the board’s core responsibilities” of guiding and developing the financial institution’s strategy and risk tolerance.
- Attention to non-core, supervisory tasks may compromise the board’s ability to efficiently focus on core responsibilities.
- The amount of information board members are being asked to assimilate in order to prepare for and participate in board meetings has become overwhelming.
“The Federal Reserve believes that revising or eliminating unnecessary, redundant, or outdated expectations, as appropriate, will allow boards to focus more of their time and resources on fulfilling their core responsibilities,” according to the announcement in the Federal Register.
What this could mean
After the financial crisis that led to the Great Recession, regulators tightened their grip on the banking industry, and many boards for financial institutions of all sizes have struggled beneath the weight of the heavier regulatory burden. In fact, the Fed admits that industry outcry, at least in part, contributed to its decision to conduct the review and craft its proposals.
Although the Fed’s proposals specifically call out large institutions ($50 billion or more in assets), portions of the proposal, if adopted, will also affect mid-sized and smaller institutions.
While the proposed LFI rating system will affect only the largest players, financial institutions of all sizes can benefit from clarification and streamlining of boards’ expected supervisory role. By shifting day-to-day supervisory responsibilities back onto senior management, the proposal could free up a significant amount of time for boards to spend on the bigger issues that move their financial institution forward — a key objective of the Fed’s proposal.
Furthermore, by establishing principles of effective board operation, the proposal could help boards of directors to better understand — and act upon — their core functions, regardless of the size of their institution.
The Fed is proposing new standards for bank boards. Recap the high points of the proposal and give some perspective on what these changes could mean for small- and mid-sized banks.
Here are some more articles if you want to read up more on this topic and hear others’ viewpoints: