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Bank Board Accountabilities

February 2, 2011

By: Larry W. Martin

The FDIC's Office of the Inspector General recently published the "Follow-up Audit of FDIC Supervision Program Enhancements" (http://www.fdicoig.gov/reports11/11-010.pdf ).  This was based on the results of 72 Material Loss Reviews completed between mid 2007 and August 2010.

The Audit identified 13 risky behaviors and trends warranting attention by the FDIC in its examination and monitoring practices of banks.  The 13 behaviors are on pages 5 & 6 of the above link. 

One of the risky behavior and trends is "Ineffective leadership from bank boards of directors (Board) and management.  As for each of the other 12 behaviors and trends, the Audit provides information on FDIC actions to address the item. 

Following is the section from the report dealing with bank boards and management.  We thought you might find it helpful to know what the FDIC, and possibly other agencies, are learning and implementing from the rash of failures these past few years.

Assessment of Bank Boards of Directors and Management

The Board and management for many of the failed institutions that were the subject of MLR (material loss reviews reports failed to (1) effectively identify, measure, monitor, and control risk;(2) ensure compliance with laws, and regulations, policy, and regulatory orders; and(3) effectively manage de novo banks. In addition, some of the failed banks employed compensation arrangements with incentive or bonus features that appeared to promote asset growth, without adequate consideration of loan quality. Further, bank management failed to provide timely and adequate attention to ensure that examiner and audit recommendations intended to correct identified deficiencies were implemented.

Our MLRs) also showed that examiners sometimes identified dominant board members or senior bank management, but the institutions did not effectively mitigate the risk associated with those dominant officials. The Examination Manual indicates that there are at least two potential dangers inherent in a "One Man Bank" situation: (1) incapacitation of the dominant officer may deprive the bank of competent management and (2) problem situations resulting from mismanagement are more difficult to solve through normal supervisory efforts. The manual notes that in "One Man Bank" situations, it is extremely important that examiners assess the bank's control environment and, when applicable, recommend necessary changes to the control structure. Nevertheless, we noted that the examiners frequently did not identify in examination reports a bank's lack of controls over a dominant board member or their determination that a dominant Board member had negatively influenced bank operations until the bank's financial condition had deteriorated and/or the last examination before the bank failed.

 FDIC Actions to Address Bank Boards and Management

In addition to actions taken to address excessive compensation discussed previously, the following are examples of actions that the FDIC has taken to address the role that bank

Boards and management have played in many of the failures that we reviewed.

Specifically, the FDIC:

  • implemented the Forward-Looking Supervision training, which recognized that the following are indicative of elevated risk associated with management: exhibiting a high appetite for risk, changing the bank's business plan, being unresponsive to examiner recommendations, paying excessive compensation, and having a dominant official. Accordingly, examiners were instructed to address these types of issues in the MRBA (Matters Requiring Board Attention) section of the examination report, which is explained below.

  • instituted a process that requires examiners to (1) record significant issues and recommendations that require attention by the Board in examination reports, including those related, but not limited to, high-risk business strategies, inadequate risk mitigation strategies, dominant management, and apparent violations and policy/procedural weaknesses, and (2) proactively monitor bank responses and actions to address those issues. In addition, examination reports should include an MRBA section that focuses on issues that if not properly measured, monitored, and controlled, could adversely impact the institutions.

DSC (Division of Supervision and Consumer Protection) regional offices are to include the MRBA issues in the examination report transmittal letters, request timely responses from bank management, track the recommendations, monitor the bank's progress in addressing them in the post examination period, provide feedback to banks between examinations, and take appropriate corrective action to address inadequate or ineffective actions to address these issues.

Further, the FDIC has enhanced actions relative to the management of de novo banks, bank board and management compliance with business plans and regulatory orders, and the risk associated with those banks, as discussed in the next section of this report. Those actions require more effective communication between the banks and the FDIC regarding growth, funding strategies, concentrations, revisions to business plans, and more timely communication of requests to deviate from previously-approved business plans. In addition, the FDIC has issued more guidance to address bank management's appetite for high-risk concentrations and nonresponsiveness to examination recommendations, as discussed later in this report.

As previously discussed, DSC established an internal post-MLR assessment requirement.

Our analysis of the 51 post-MLR memoranda that DSC's regional offices submitted as of August 2010 clearly indicates that, among other issues, examiners identified dominant bank officials as a significant concern and made suggestions and/or identified lessons learned regarding dominant officials. Those suggestions and/or lessons learned included the following:

  • dominant officials present unique supervision challenges, and such influence\ without an appropriate independent Board or internal controls creates an environment for abuse and poor risk selection;

  • offsite monitoring and application review, including those for de novo banks, and approvals should be enhanced to include consideration of dominant officials, coupled with other risk factors;

  • director education requirements should be (1) encouraged by examiners to assist in preparing Board members to perform their responsibilities and enhance their abilities to identify potential risks and (2) included in informal corrective programs when a dominant official and a weak Board are evident in a financial institution;

  • closer supervision for banks that have dominant officers should be provided and the level of involvement of individual board members needs close scrutiny; and

  • a more forward-looking approach in the assessment of management and the bank's Board, especially when deficiencies have been identified related to reporting to the Board and possible "red flags" regarding a dominant officer are evident, may be needed.

 At the suggestion of one of DSC's regional offices, the Forward-Looking Supervision training included a case study that, according to a DSC official, (1) instructed examiners to be cognizant of "red flags" related to dominant influence or concentrations of authority during their assessment of a bank's Board and/or management, including the assigned

CAMELS rating, and (2) recognized the need for increased supervision and review of a bank's internal controls and possible coordination with independent directors when dominant management is identified. Although the Forward-Looking Supervision training addressed dominant influence to some degree, we noted that the FDIC has not issued additional guidance or otherwise reemphasized existing guidance related to examination coverage and identification of risks related to institutions with dominant officials.

Therefore, the FDIC should review existing examiner guidance to determine whether a reiteration of that guidance and/or communication and clarification of DSC's expectations of its examiners with respect to this issue would be beneficial.

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