The Board of Governors of the is seeking public comments on a corporate governance proposal intended “to enhance the effectiveness of boards of directors.”
The Fed is inviting comment on a proposal addressing supervisory expectations for the boards of directors of bank holding companies, savings and loan holding companies, state member banks, U.S. branches and agencies of foreign banking organizations, and systemically important nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve.
For the largest domestic bank and savings and loan holding companies and systemically important nonbank financial companies, the proposal would establish principles regarding effective boards of directors focused on the performance of a board’s core responsibilities. The proposal would also better distinguish between the roles and responsibilities of an institution’s board of directors and those of senior management.
For domestic bank and savings and loan holding companies, the proposal also would eliminate or revise supervisory expectations contained in certain existing Federal Reserve Supervision and Regulation letters, which would be aligned with existing or proposed guidance for boards depending on the size of the firm.
The proposal would refocus the Federal Reserve's supervisory expectations for the largest firms' boards of directors on their core responsibilities. The potential move, the Board of Governors says, “will promote the safety and soundness of the firms.”
“Boards' core responsibilities include oversight of the types and levels of risk a firm may take and aligning the firm's business strategy with those risk decisions,” a statement released on Aug. 3 says. “Additionally, the proposal would reduce unnecessary burden for the boards of smaller institutions.”
The corporate governance proposal identifies the attributes of effective boards of directors, such as setting a clear and consistent strategic direction for the firm, supporting independent risk management, and holding the management of the firm accountable. For the largest institutions, Federal Reserve supervisors would use these attributes to inform their evaluation of a firm's governance and controls.
The proposal would also clarify that for all supervised firms, most supervisory findings should be communicated to the firm's senior management for corrective action, rather than to its board of directors. The plan also identifies existing supervisory expectations for boards of directors that could be eliminated or revised.
The Fed’s rethinking of board responsibilities is the latest effort to potentially ease enhanced prudential standards imposed by the Dodd-Frank Act. Congress, through deregulatory efforts under consideration by Congress and the Treasury Department have specifically targeted the increasing demands put upon directors at banks.
During an April 20 speech at the Global Finance Forum in Washington, D.C. Governor Jerome Powell addressed oversight of bank boards.
“We need to allow boards of directors and management to spend a smaller portion of their time on technical compliance exercises and more time focusing on the activities that support sustainable economic growth,” he said.
“I support adjustments designed to enhance the efficiency and effectiveness of regulation without sacrificing safety and soundness or undermining macroprudential goals,” he added, regarding the Fed’s supervisory relationship with the boards of directors of banking firms.
“After the crisis, there was a broad increase in supervisory expectations for these boards. But it is important to acknowledge that the board's role is one of oversight, not management,” Powell said. “We need to ensure that directors are not distracted from conducting their key functions by an overly detailed checklist of supervisory process requirements. Rather, boards of directors need to be able to focus on setting the overall strategic direction of the firm, while overseeing and holding senior management accountable for operating the business profitably, but also safely, soundly, and in compliance with applicable laws.”
The new proposal was informed by a multi-year review by the Federal Reserve of practices of boards of directors, particularly at the largest banking organizations. 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 Federal Reserve also reviewed expectations contained in board supervisory guidance.
Among other things, the results of the review and discussions with independent directors suggest that supervisory expectations for boards of directors and senior management have become increasingly difficult to distinguish.
“Greater clarity regarding these supervisory expectations could improve corporate governance overall, increase efficiency, support greater accountability, and promote compliance with laws and regulations,” the Fed wrote. “The results of the review also suggest that boards often devote a significant amount of time satisfying supervisory expectations that do not directly relate to the board’s core responsibilities, which include guiding the development of the firm’s strategy and the types and levels of risk it is willing to take, overseeing senior management and holding them accountable for effective risk management and compliance among other responsibilities, supporting the stature and independence of the firm’s independent risk management and internal audit functions, and adopting effective governance practices.”
Boards completing such non-core tasks “may do so at the expense of sufficiently focusing on their core responsibilities, which when exercised effectively promote the safety and soundness of the firm,” the proposal adds.
The results of the review suggest that boards of large financial institutions face significant information flow challenges, especially in preparing for and participating in board meetings.
“Absent actively managing its information flow, boards can be overwhelmed by the quantity and complexity of information they receive,” the Fed wrote. “Although boards have oversight responsibilities over senior management, they are inherently disadvantaged given their dependence on senior management for the quality and availability of information.”
The proposed guidance would facilitate the execution of boards’ core responsibilities by clarifying expectations for communicating supervisory findings to an institution’s board of directors and senior management. The proposed guidance would indicate that the Federal Reserve expects to direct most Matters Requiring Immediate Attention (MRIAs) and Matters Requiring Attention (MRAs) to senior management for corrective action.
The proposed guidance “better distinguishes” the supervisory expectations for boards from those of senior management, and describes effective boards as those which: set clear, aligned, and consistent direction regarding the firm’s strategy and risk tolerance; actively manage information flow and board discussions; hold senior management accountable; support the independence and stature of independent risk management and internal audit; and maintain a capable board composition and governance structure.
The Board is also requesting public comment on a proposal to better align the Board's rating system for large financial institutions with the post-crisis supervisory program for these firms.
The current supervisory program for the largest firms was introduced in 2012 and sets higher standards to lower the probability of a firm's failure or material distress and reduce risks to U.S. financial stability. The proposed changes to the rating system will incorporate the regulatory and supervisory changes made by the Federal Reserve since 2012, which focus on capital, liquidity, and the effectiveness of governance and controls, including firms' compliance with laws and regulations. Supervisors would assess and assign confidential ratings in each of these categories.
The proposed rating system would only apply to large financial institutions, such as domestic bank holding companies and savings and loan holding companies with $50 billion or more in total consolidated assets, as well as the intermediate holding companies of foreign banking organizations operating in the United States.
Consistent with existing practices, the new rating system would not apply to insurance companies supervised by the Board. Firms with less than $50 billion in total consolidated assets, including community banks, would continue to use the current rating system, which reflects long-standing supervisory practices for those firms.
Comments will be accepted for 60 days.