RBS’s board lessons

By Lucy P. Marcus
December 19, 2011

By Lucy P. Marcus

The views expressed are her own.

Last week the UK’s Financial Services Authority (FSA) released a report on the near collapse of Royal Bank of Scotland (RBS), the overambitious institution that took over ABN Amro and then had to be bailed out by the British government to the tune of £45 billion ($70 billion) in 2008. It is one of several financial institutions around the world that have encountered serious difficulties in the past several years, but this report is particularly edifying.

The report has harsh words for the board of RBS, and highlights some of the failures of the RBS board in a way that provides an implicit warning for board members of financial institutions. The lessons that can be gleaned from looking at the RBS case are valuable for any director serving on the board of any business.

BOARD SIZE

One of the issues that the FSA report highlights is that of a board’s size. In the case of RBS, the FSA Report points out that the sheer size of the 17 director RBS board reduced the board’s overall effectiveness. As the report notes, it was possible that the having such a large board “made it less manageable and more difficult for individual directors to contribute, hence reducing overall effectiveness.”

There clearly is such a thing as an effective size that ensures that there are enough voices with sufficient expertise around the table to allow for real interaction and deliberation. Academics and consultants will give all sorts of opinions as to what the ideal size is, but board members, and indeed board chairs, know without scholarly assistance when the board has become unmanageable and unwieldy. I’m partial to seven to nine members, depending on the size of the company. Much larger than that and you can be in danger of ending up with a two tier board, where some people can be more committed or involved, and others…not. It is equally important to have a board that is not too small—a critical mass of diverse expertise, background, and opinion is crucial to ensure substantive debate around issues affecting the organization’s performance and direction.

INDEPENDENCE OF THOUGHT AND ACTION

Such diversity is important to avoid another danger the FSA Report points out the RBS board suffered from: “group-think.” As the report notes, boards benefit from “some divergence from consensus.” In the case of RBS, it was noted that “rigorous testing, questioning and challenge that would be expected in an effective board process dealing with such a large and strategic proposition” as the ABN AMRO acquisition was.

I think of this as a healthy friction – a slight sand in the oyster that is not enough to be destructive, but enough to create dynamism and discussion. In light of this, it is essential that a board be composed of people who are not afraid to speak up at the critical time – the time when everyone seems to be agreeing even though there is still something niggling at the back of our heads. Every nonexecutive director has been in that position, and as hard as it seems to speak up, it is exactly at that critical juncture when we need to. The more diverse a board is in terms of thought, experience, knowledge, understanding, color, age, international perspective, gender, etc., the more likely is it that someone will feel this niggling and raise the issue that could be the critical one.

It is never pleasant to be the board member who is seen as the “hold out”, but I’ll think of this finding in the report, and RBS, every time I get “the look” for being the one to ask the question that holds up adjourning for dinner.

Part of the benefit of diversity in the board room is ensuring that there is a collection of people with “deep experience” in the core business of the organization, something the FSA Report pointed out as critical. Aside from the obvious point of creating a strong board, from an individual board director’s perspective, this is a reminder to all of us not to take up a board seat if we don’t feel we have the expertise that is required to do the job properly. No one person can be an expert in all things, but I do think we should decline if offered a post where we are always going to be in catch-up mode.

ACTING IN THE INTEREST OF THE BUSINESS AND ITS STAKEHOLDERS

One point that struck me as subtle but essential was that the FSA Report criticized the board for having “displayed inadequate sensitivity to the wholly exceptional and, compared with other companies, unique importance of customer and counterparty confidence in a bank and its chosen strategy.” This referred to the fact that they conducted “only extremely limited due diligence in respect of the ABN AMRO acquisition” rather than recognizing as a financial institution that even greater care was required. The report found that the “acquisition was not characterised by the degree of moderation and sensitivity to strategic risk appropriate to a bank.”

The reason I thought this passage was so important is that it serves as a reminder to directors that though a plan, be it an acquisition, investment, or expansion opportunity, might seem sensible on paper, and might appear, in a vacuum, to be the best plan in the world, we still need to make sure it makes sense for this particular business and serves the long-term interests of all its stakeholders, and not merely the short-term interests of current shareholders. As the FSA report noted, in the case of RBS, there was real concern that the board was “much more focused on revenue and profit than on the size of the balance sheet.” As board members we have all been faced with opportunities that arise and seem too good to pass up, but it is a brave, and ultimately competent and responsible board that can, and must, take that decision if it doesn’t make sense for the business at that time.

BOARD PAPERS

Another area that the FSA Report on RBS shines a light on is the issue of board papers sent to directors – their veracity, their completeness, and whether they are wholly adequate for making wise and well considered decisions. The report questions whether the board “assured themselves that they were receiving adequate information” and whether this information was complete so that informed decisions could be made. As board members, the expectation is that at a minimum we must read the papers sent to us, be they regular board papers, or project specific papers. The question arises, though, is that enough? Board papers can, and often are, prepared with a point of view, and may not always contain all of the information we need. It behooves board members to question the assumptions behind the papers and request more data if needed. Also, beyond asking questions of the executive team, it is the wiser part of valor not to depend solely on the information provided. In the digital age we have at our finger tips the ability to quickly and easily seek out other sources of data, and it is incumbent upon us to do just that, and particularly for the big decisions we are asked to make.

Don’t just take my word for it. I’d encourage any director to read Part 2 of the FSA Report on The Failure of the Royal Bank of Scotland, which focuses on management, governance and culture. Captured within it is a reminder of what engaged committed directors need to think about every time they read their board papers, walk into a board dinner, or attend a board meeting.

In many ways, this report, and other high profile discussions around board room performance, such as that of MF Global, is a real boon. It is a gift for non-executive board directors who strive to be strong contributing individuals in the board room. I’ll be thinking of these reminders the next time I’m a lone voice in the board room, and I think a lot of other directors will take reassurance and courage from them when they are in that position as well.

7 comments

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Lucy, you raise and discuss some excellent points. Thank you also for positively commenting on my own blog on the topic, where I go into some other areas, particularly related to risk management and internal audit, as well as touching on some of the same points. My blog is at http://www.theiia.org/blogs/marks/index. cfm/post/Governance%20and%20Risk%20Manag ement%20Failures%20Contributed%20to%20Fa ilure%20of%20Major%20UK%20Bank

Posted by normanmarks | Report as abusive

This is a short but very insightful. I appreciate that

Posted by FrancisBoateng | Report as abusive

Reading this enlightened assessment, I was very much reminded of Tokyo Electric Power Company (TEPCO) operating the Fukushima Dai-ichi nuclear power station. The fuel of three reactors at the power station melted down in the wake of the March 11, 2011, earthquake and tsunami, contaminating land and sea with catastrophic consequences. TEPCO seems to have entirely misjudged the risks involved in operating nuclear reactors on the seashore of an earthquake and tsunami-prone country and therefore was unpreprared to shutdown the reactors safely under extreme emergency conditions.

Without sufficient room for discourse and deliberation, appropriate risk evaluation seems impossible. Human organizations must reflect the degrees of freedom that our minds and brains afford.

Read more here:
http://brainmindinst.blogspot.com/2011/1 2/tepco-and-toad-neuroethological.html

Posted by PeterMelzer | Report as abusive

Great comment Lucy. Especially the point about extra vigilance about trophy transactions for which the incentives are stacked in favour of the short-term (not least because of the metrics the board have approved!)

In my work on Preventable Surprises I have found ambassadorial or otherwise ineffective boards combined with over-dominant/saviour CEOs to be one of the 6 key drivers of crisis.

I’d love to know what you and your readers make of this thinking.

Pls see http://www.preventablesurprises.com

Posted by DrRajT | Report as abusive

Nice piece. Thank you. Am I being anal (or naive) by suggesting we might also address (to a degree) the need for due diligence in making judgements by having reports structured in a way that requires contrasting views – and their evidence base- to be presented for consideration?

Posted by JohnSalter | Report as abusive

Thanks. Another great, concise piece for my file on leadership behaviour.
It seems to me that the actual physical board meeting event is becoming more redundant: perhaps at best a team-building exercise and at worst a token gesture. Most of real work of the board-team and it’s individual members could be done in the background e.g. innovation, throwing ideas around, sense-checking (using competence & diversity), future-proofing, stargazing & tick-boxing, even asking the “awkward questions” that perhaps wouldn’t have come to mind during a meeting – all using a virtual-boardroom space. To facilitate this, the board-organism (or it’s mind) should be “constantly active”, in order to effectively utilise it’s combined diverse resource.
By the time the board actualy get together, many of the key items and really critical decisions have been thrashed around, allowing space for “team-cohesion” and a bit of “creative-sparking”.

Posted by Dr_JAH | Report as abusive

Commitees and Boards record minutes of their meetings and votes. Search back on RBS’ and you will find the discussion concerning the aquisition of the company that derailed them. Find out who was opposed. Save them and fire the rest.

Posted by RealOscar | Report as abusive