Bank governance datapoint of the day

By Felix Salmon
May 20, 2009

David Reilly reckons we should have bankers overseeing banks:

Only about 15 percent of directors have banking experience at the 10 largest U.S. commercial banks by assets, according to my own analysis. Include directors with investing, accounting, insurance or real estate backgrounds and the rate creeps up to only 33 percent…

Bank directors also include academics, politicians, retired military officers and heads of nonprofit groups such as the Pennsylvania Horticultural Society. There are more of these folks than non-executive directors with banking experience at the banks I examined.

This is startling, and I’d be inclined to agree with him — if he did a bit more empirical work. Looking at the percentage of directors with banking experience is just step one; the second step is to see if there’s any correlation between the number of directors with banking experience, on the one hand, and the performance of the bank, on the other. Reilly writes:

To understand what might sink a bank, directors needed a grasp of instruments like collateralized debt obligations and off- balance-sheet entities like conduits or structured investment vehicles…

Boards with more investing, finance and accounting experience may be better positioned to deal with today’s quickly evolving financial industry.

Or, they may not: bankers have proven themselves, over the past couple of years, to be just as oblivious as everybody else when it comes to complex products and systemic risks.

So let’s do a bit of homework here, and see whether banks with boards with lots of financial experience are less likely to lose money, or less likely to blow up, than banks with few such board members. Then we can start pushing them to make changes, starting with the chairman of BofA.

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Comments
4 comments so far

Changing the selection process for boards may be one solution, but the real problem had become poor risk management. Boards, by design, meet 10-12x per year; how in the heck can 10-15 people understand what Citigroup had been or is doing? Board governance is an issue…but it’s broader than just banking / financials.

It is risk management that has to fundamentally change. Risk management, empowered to inform a top trader his VAR is too high; or that yes, the CDO machinery needs to diminish; or that yes (Citigroup) all these SIV entities do require posting some risk capital . Compensation would be the 3rd leg on this stool…short-term incentives for longer-dated risk? what ever could go wrong…

Posted by Griff | Report as abusive

They may not fully understand everything being discussed, but they contribute independence, which also has value.

For example, if you pack the boards with people with bank experience you’ll fill the boards with insiders that will tow the CEO’s line on pay and risk taking.

As of July, 2007, I had never heard of CMBS, conduits, SIV’s, synthetic CDS’s, you get the picture. By that Labor Day, I’d learned a whole bunch, really fast. A leader of a horticultural society may not be a natural pick for a bank board, but that isn’t to say that they couldn’t ascend a learning curve.

Posted by Wendell | Report as abusive

“bankers have proven themselves, over the past couple of years, to be just as oblivious as everybody else when it comes to complex products and systemic risks.”

I’m not so sure. This worked out pretty well for the banks – considering what happened. They gave themselves the opportunity to earn huge fortunes – and failure didn’t cost them all that much. There banks should be in bankruptcy and these guys and few gals should have been fired sans parachutes or pensions.

If you and I take those risks, there is no bailout.

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