SEMINAR FOR SENIOR BANK SUPERVISORS

Transcription

1 SEMINAR FOR SENIOR BANK SUPERVISORS World Bank/IMF/Federal Reserve Risk Governance & the Role of the Board Progression Through International Standards Laura Ard Lead Financial Sector Specialist Financial Markets World Bank 18 October 2016

2 Outline 1 1. Introduction -» Definition» Corporate Governance - Contributing Factors to GFC 2. Risk Governance: Standard Setters Response (SIE, FSB peer review) 3. WB Bank Governance Reviews Overall Observations 4. Risk Governance: Basel Committee Update - Corporate Governance Principles for Banks 5. Current Issues: Emphasis on Risk Culture; Challenges for Boards 6. Supervisory Suggestions

3 1. Corporate Governance Defined Corporate governance is the system by which companies are directed and controlled a set of relationships between a company s management, its board, its shareholders provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined Source: Sir Adrian Cadbury, UK Combined Code; OECD Corporate Governance Principles,

4 1. Contributing Factors to the Global Financial Crisis (GFC) Recap - Senior Supervisors Group Report (2009) 3

5 Governance Role in Global Financial Crisis (Senior Supervisors Group Report, 2009) Overarching observation of the SSG: Weaknesses in governance, incentives, and infrastructure undermined the effectiveness of risk controls and contributed to (2008) systemic vulnerability Unwillingness or inability of boards of directors and senior managers to articulate, measure, and adhere to a level of risk acceptable to the firm Arrangements that favored risk takers at the expense of independent risk managers and control personnel, Compensation plans that conflicted with the control objectives of the firm, and An inadequate and often fragmented infrastructure that hindered effective risk identification and measurement 4

6 Governance Role in Global Financial Crisis (Senior Supervisors Group Report, 2009) Boards didn t understand the risks being taken by management Disparity between the risks that their firms took and those that their boards of directors perceived the firms to be taking Insufficient evidence of active board involvement in setting the risk appetite for firms in a way that recognizes the implications of that risk taking Boards did not actively determine that effective boundaries for risk taking were set in advance Rarely did supervisors see firms share with their boards and senior management: Robust measures of risk exposures (and related limits) The level of capital that the firm would need to maintain after sustaining a loss of the magnitude of the risk measure, and The actions that management could take to restore capital after sustaining such a loss 5

7 Governance Role in Global Financial Crisis (Senior Supervisors Group Report, 2009) 10 critical areas for continued improvement o Board and Senior Management Oversight o Articulating Risk Appetite o Compensation Practices o Risk Information Technology Infrastructure o Risk Aggregation & Concentration Identification o Stress Testing o Credit & Counterparty Risk Management o Valuation Practices o Operations & Market Infrastructure o Liquidity Risk Management 6

8 Global Financial Crisis: Systemic Failures of Risk Governance The GFC evidenced many examples of cognitive failure at the Board level Boards lacked the willingness or ability to anticipate risk and set boundaries on desirable risks Internal structures and risk governance were substantially underdeveloped and therefore, could not raise critical red flags 7

9 2. Standard Setters Response: - SIE Report (2011 / 2012) - FSB Third Thematic Peer Review on Risk Governance (2013) - BCBS Corporate Governance Principles for Banks (July 2015) 8

10 Focus on Risk: Supervisory Intensiveness and Efficiency of SIFIs (systemically important financial institutions) A report on the intensiveness and effectiveness of SIFI supervision (the SIE Report ) was issued by the FSB on November 1, 2010; follow up report Oct 2011 reviewed supervisory and firm progress: Effective risk appetite frameworks (RAF) that are actionable and measurable by both firms and supervisors are not yet widely seen. Supervisory expectations for controls were rising but one area the risk management function at SIFIs was still not be considered strong. More intense supervisory oversight is needed to evaluate the effectiveness of improved corporate governance, particularly risk governance. 9

11 Focus on Risk: Supervisory Intensiveness and Efficiency of SIFIs (cont) Many firms had made progress in conceptualizing and articulating a risk appetite statement; however, supervisors observed few changes in risk culture. While progress was being made at both the supervisory and firm levels toward strengthening the Chief Risk Officer s organisation, most were not yet considered strong. The 4 th recommendation in the 2011 Report directed an FSB Peer review on risk governance 10

12 Focus on Risk: FSB Third Thematic Peer Review Risk Governance (February 2013) Progress: Supervisors had: Developed or strengthened regulation / guidance Elevated supervisory expectations for risk management Engaging more frequently with board and management More frequently accessing adequacy / accuracy of board information 11

13 FSB Third Thematic Peer Review Risk Governance (February 2013) (cont) Progress: Firms in regions hardest hit by the crisis have generally made the most progress in strengthening risk governance. Assessing collective qualifications and effectiveness of boards (self evaluation or third party review) Making significant progress in strengthening composition of board Establishing Board Risk Committees with independent directors & defining independence Establishing group-wide CRO and risk mgmt function with independence and authority Integrating discussions between risk & audit committees 12

14 FSB Third Thematic Peer Review Risk Governance (February 2013) (cont) 13 Issues Cited: Authorities need to engage further with boards, risk and audit committees Board and/or Risk Committee need to further elevate the role of the CRO (appointment, CRO objectives/performance, access to Board and Risk Committee (in-camera sessions with nonexecutives) Risk Committees need more developed objectives, procedures More work required (by authorities and firms) on establishing integrated risk appetite framework (RAF) No jurisdiction has specific expectations for internal audit to perform firm-wide assessment of risk mgmt / governance CAE (chief audit executive) requires more access to full Board (and in-camera sessions with non-executives)

15 3. WB Bank Governance Reviews Overall Observations 14

16 Overall Observations in WB client countries (Bank Governance reviews conducted in 17+ countries) Board: Lack of objectivity (independence) and separation of functions ((controlling) ownership, oversight, mgmt); lack of recognition for need of strong risk governance / management Board: understanding of role public trust responsibility; risk governance responsibility Risk committee increasingly common but need defined role; MIS Need for formalization of risk mgmt; establish CRO role, define independence (removing from business line); access & report to risk committee and full board; input into risk strategy prospective risk profile; authority; skills; resources (substantially lacking); Very few if any independent assessments of risk governance framework by internal audit or other Chief Auditors require more fluid access to full boards and in-camera 15 sessions with non-executive board members

17 4. Basel Committee Update July 2015: Corporate Governance Principles for Banks 16

18 Basel Committee Corporate Governance Principles for Banks - July Took into account FSB findings & other relevant pieces of work) Proportionality: commensurate with the size, complexity, structure, economic significance and risk profile of the subject bank and the financial group to which it belongs. SIFIs to have in place risk governance structure and practices commensurate with their role in and potential impact on national and global financial stability Jurisdictional differences: Different terminology and structures Board and senior management; one-tier/ two tier structures; executive and non-executive positions Applicability of national laws

19 Basel Committee Corporate Governance Principles for Banks - Update Explicitly reinforces the risk governance responsibilities at the board level Emphasizes key components of risk governance: risk culture, risk appetite, and their relationship to a bank s risk capacity Delineates specific roles of the board, board risk committee, senior management and the control functions including the CRO and internal audit 18

20 BCBS Corporate Governance Principles for Banks board function The Board should take an active role in developing the risk appetite: Risk appetite development may be initiated by senior management (CRO) BUT successful implementation = effective interactions between the board, senior management, risk management and the business line (+ CFO) (top down / bottom up) Risk appetite should align with bank s strategic, capital and financial plans and compensation practices Board should oversee adherence to the risk appetite statement, risk policy and risk limits 19

21 BCBS Corporate Governance Principles for Banks - risk function Principles reinforce independent risk management function under the direction of a Chief Risk Officer (CRO) Responsibilities: overseeing risk activities across the enterprise with sufficient authority, stature, independence. Activities: identify, assess, measure, and monitor aggregate and emerging risks; develop & implement enterprise-wide risk governance framework (incl. risk culture, risk appetite, risk limits); establish system for limit / risk appetite breaches; influence / challenge material risk decisions; reporting Independence (no dual hatting ) & and relationship with business line Adequate resources, budget, staffing, training 20

22 BCBS Corporate Governance Principles for Banks - risk function Includes: Expanded CRO responsibilities (inter alia): Enhance RM systems, quantitative models, reports to support risk taking activities Support Board in its oversight of development of risk appetite and translating the risk appetite into risk limit structure ** Manage & participate in key decision making processes (strategic planning, capital / liquidity planning, new products, compensation design / operation) ** Articulate risk and effectively interface with business, board, management ** CRO appointment, dismissal, change of position 21 Should be approved by Board / RC Performance, compensation, budget reviewed & approved by Board / RC

23 22 5. Current Issues: Culture & Board Challenges

24 Current issues: Emphasis on Corporate (& Risk) Culture Establishing a strong risk culture is of paramount importance in ensuring effective risk management a Board & CEO Board responsibility Most important determinant of risk management effectiveness? Formal channels may not identify all emerging concerns and rapid risk changes, therefore informal channels for information are essential - To effectively balance risk & return at every level, banks should: Deliberately create environment that encourages dialogue about risk Make it safe for employees to question/challenge/escalate things that they don t understand, and then reward this behavior Thereby supporting the need for management and staff to anticipate risk rather than relying only on historical determinants to predict risk SOURCE: Implementing Robust Risk Appetite Frameworks to Strengthen Financial Institutions (IIF Steering Committee on Implementation Report), June 2011 ( and The Mark Lawrence Group; FSB Guidance on 23 Supervisory Interaction with Financial Institutions on Risk Culture April 2014

25 Elements of Risk Culture (cont) Central elements of an effective risk culture include Horizontal information sharing Vertical escalation of threats or fears Continuous and constructive challenging of the organization s actions and preconceptions Committed leadership Incentives that reward thinking about the whole organization SOURCE: Implementing Robust Risk Appetite Frameworks to Strengthen Financial Institutions (IIF Steering Committee on Implementation Report), June 2011 ( and The Mark Lawrence Group; FSB Guidance on Supervisory Interaction with Financial Institutions on Risk Culture April

26 Current Issues: Implications for the role of Boards Changing regulatory and risk landscape is creating new challenges for Boards: More onerous regulation is requiring boards to spend significantly more time on risk issues and managerial oversight some opine this runs the risk of shifting focus away from strategic decision making in the firm s interest Policeman role rather than fostering good mgmt. Composition requirements (risk, accounting, finance) may run the risk of creating boards with more homogenous backgrounds at the expense of valuable breadth of background and skills sets Individual independent directors to challenge status quo, investigate, anticipate risks are they successful? SOURCE: The Salzburg Global Seminar: Session Report Corporate Governance in the Global Economy: The Changing Role of Directors, October

27 Implications for the role of Boards Supervisors should strike a balance: Individual director independence versus collective objectivity (employment of a contrarian director with formal charge to question (herd mentality) and report views (in writing)) Prescription of board skills versus diversity of skills & background (balance of steeped experience with the need new, innovative people with specific skills, e.g. IT, cybersecurity, social media, etc.) composition is more art than science Board focus short term versus long term; focus on crating long-term value can help to clarify choices and reform board behaviors (culture) engenders loyalty and prudence Board training SOURCE: The Salzburg Global Seminar: Session Report Corporate Governance in the Global Economy: The Changing Role of Directors, October

28 6. Supervisory Suggestions Supervisors should continue to: Evaluate board s understanding of its role and draw concrete conclusions on adequacy of board oversight and the manner in which it anticipates risk (through internal risk identifications systems, culture & tone at the top, etc.) Further elevate focus on risk governance (including risk appetite), internal risk management structure, and role, function, and independence of risk management (CRO) Periodically evaluate the systems established by board / management to form judgements on risk framework and corporate culture Encourage director (board) assessments of board processes third party evaluations Periodic risk governance framework assessments by internal audit or external party 27

29 28 THANK YOU