Jan Peter Buchholz
Partner CASIS Wirtschaftsprüfung
Bankspezialist CASIS Wirtschaftsprüfung
On 21 June 2016, the European Central Bank (ECB) published its statement and expectations on the thematic review on the board governance and their risk appetite frameworks (RAF). An in-depth assessment of the institutions’ management bodies and their RAFs was conducted in 2015 across all significant institutions (SIs) in the euro area through a thematic review. Exercising Single Supervisory Mechanism (SSM), ECB performed deep and granular assessments of banks’ management bodies in charge of supervisory and management functions.
The report conveys some lessons from the thematic review, describes good practices observed and sets out supervisory expectations regarding a bank’s board and risk appetite framework. The report was not intended to give a new exhaustive guidance on effective governance and risk appetite framework. There are no immediate effects on the institutions. From a national, German point of view, it appears challenging to derive immediate need for action from the published general principles – at least for those banks that comply with regulations of the German Banking Act (KWG) on particular organisational duties for risk management (including MaRisk), management and supervisory board. „Management bodies“ as delineated in the review refer, when transferred to the national two tier system, to the supervisory board (Art. 4 Abs. 10 CRR, § 25d KWG).
Supervisory expectations regarding the functioning and effectiveness of boards
As one of the key drivers of effectiveness, the board should be composed in such a way that it allows an effective and independent supervision of management. With regard to the board’s composition, the focus areas were identified as size and structure, independence, collective knowledge, diversity of board members, and succession planning. The SSM states that size and structure of the board can have an impact on the quality of debate on the board and hence on its effectiveness.
While a large board may hinder interactive discussions and small boards conversely may face lack of diversity, the size of a board should not adversely affect its functioning. When it comes to the structure of the board, the report outlines that structure and scope of committees should be clear in order to avoid confusion resulting from possible overlaps on some topics. ECB considers that separate risk and audit committees should be in place with separate chairs
The level of independence on the board as a whole and the independence of board members is connected to the board’s capacity to independently challenge senior management, whereas independence means both „formal“ independence and independence „in mind“. The latter is the ability of the board member to perform their duties, without having any potential conflicts of interests. In order to avoid conflicts and to promote a balanced work base, the proper management of potential conflicts in an adequate conflicts of interest framework is necessary.
The board should possess adequate collective knowledge, expertise and diversity to be able to understand the institution’s activities and main risks. The thematic review identified that areas of expertise should be strengthened to ensure risk awareness and provide an adequate debate quality, for example IT and Accounting. The SSM points out that it expects all board members to be in a position to understand the business model of the institution and the regulatory framework and to be able to challenge executive members. Thus, it was suggested that any potential gaps of knowledge need to be identified and corrective actions should be taken.
The review identified that the continuity of activity on the board is influenced by adequate succession planning, especially if some board members have key areas of expertise as part of the collective knowledge. The SSM expects institutions to develop and implement mechanisms through a succession process. As an example for best practice, the profile of possible future candidates could be defined in advance.
Since boards need to challenge, approve and oversee the management’s implementation of the bank’s strategic objectives and governance framework, the SSM expects the board to demonstrate a capacity for strong, independent challenging and oversight of the management body. The quality of debate is linked to the capacity to independently challenge the management. The thematic review concluded that the quality of debate could be improved by optimizing the frequency and length of meetings, especially if time of debate is too limited or frequency of meetings is low.
Furthermore, prepared board documentation should be provided sufficiently in advance to enable board members to read and analyse it. Board members are expected to play a proactive role in preparing the agendas of meetings, suggesting topics to be discussed. This should be preferred to leaving setting the agendas to senior management.
The chair of the board is responsible for interactions among board members, especially to foster an interactive discussion and to encourage members to present their different views. A concentration of power, domination of the debate and information asymmetries should be avoided. Boards need to have the relevant information required to make decisions at their disposal. The quality of documentation and relevant information has an influence on the quality of debate. Shortcomings in the quality of a bank’s internal documentation might reduce the quality of debate on the board and as a consequence its ability to have an appropriate understanding of the risk situation.
The SSM stresses the importance of preparing clear and concise documentation. Documentation should be tailor-made to the board’s needs, i.e. with executive summaries and highlighting the risks, opportunities, costs and benefits of the various items. In addition, appropriate records of board meetings and decisions should be in place, so that they provide an adequate summary of matters reviewed, recommendations made, decisions taken and dissenting opinions.
Regarding the oversight of the internal control framework, the report recommends enhancing the interaction between control functions (risk, internal audit, compliance) and the board. The board should have direct access to the heads of internal control functions. The heads of the internal control functions should report regularly directly to the responsible member of the board.
Supervisory expectations regarding the risk appetite framework
Regarding the supervisory expectations, the design of the risk appetite framework has an impact on its effective implementation. Together with a strong risk culture and well-defined responsibilities for risk management and control functions, the RAF can be defined through the risk appetite statement. For validating the RAF, institutions should develop an aggregated and consolidated risk appetite dashboard, to compare the risk exposure and risk limits and the appetite for financial and non-financial risks. If the various risks have been identified, corresponding metrics should be defined. These should regard results of stress tests, forward-looking metrics, risk coverage potential and risk concentration.
To implement the RAF, institutions should ensure that the risk appetite statement contains all levels and types of risk identified. In order to facilitate a risk monitoring, it is recommended to develop risk appetite dashboards The SSM expects the board’s role in the definition of the RAFs and the monitoring to be more actively and a regularly independent review on the RAFs by the internal audit to access its effectiveness.
The SSM has high and specific expectations regarding banks’ boards. The expectations may sound familiar to BaFin-supervised banks, but they give a preview of the objective of the ECB to observe the function of the banks’ internal monitoring more precisely. This review has shown that not all significant institutions have a robust framework for risk appetite which is consistent to their overall risk profile or is integrated closely enough in every structural process of the institution. Its aim is to provide international best practice examples and the possibility to improve processes in accordance with the SSM.
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Dieser Beitrag ist erschienen im Newsletter Banken-Times AufsichtsEnglisch,
Ausgabe Oktober/November 2016.
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