If you want to find people with banking experience, one of the last places to look is inside the boardrooms of the country’s biggest banks.
Citigroup Inc. recently appointed four new directors with significant banking or investing backgrounds. Yet, such directors still represent less than a third of the industry’s independent board members. The government, meanwhile, is pressing Bank of America Corp. to expand banking experience on its board, according to reports.
The lack of relevant expertise on bank boards, which extends beyond these two institutions, is troublesome, given the complexity and turmoil of the entire financial system. It also may have contributed to strategic blunders at banks in the run-up to the credit crunch. So while moves such as those at Citigroup are welcome, a lot more needs to be done to beef up bank boards.
Bank shareholders will also benefit if boards look beyond a chief executive title and open up the now-rarefied boardroom club to include more former chief financial officers, comptrollers or chief investment officers.
That’s not to say bank boards should be stacked with industry insiders.
A good board has directors who don’t take things for granted, who ask hard questions and who can say no to the CEO, said Nell Minow, editor of the Corporate Library, a corporate governance research firm.
Still, if you’re in the business of making sausage, it pays to have some butchers on hand.
That’s not the case now. Only about 15% of directors have banking experience at the 10 largest US 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%.
About 60% of board members at these banks come from industries other than finance, ranging from technology to brewing and retail. Bank directors also include academics, politicians, retired military officers and heads of non-profit 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.
In the past, banks often sought directors from outside the financial sector to gain insight into other businesses and the broader economy. A bank had staffers knowledgeable about finance, the thinking went, so why duplicate that resource at the board level.
The problem with this approach became clear during the housing and credit booms. Bank executives were motivated by short-term incentives and took risks that board members often didn’t understand.
This happened against the backdrop of a global financial system that had become increasingly complex and intertwined.
Suddenly, it wasn’t enough for bank directors to know only about lending practices or broad business patterns. To understand what might sink a bank, directors needed a grasp of instruments such as collateralized debt obligations and off balance-sheet entities such as conduits or structured investment vehicles.
To be sure, financial expertise alone isn’t a cure-all. Citigroup tripped badly even though its board included Robert Rubin, the former treasury secretary and former co-chairman of Goldman Sachs Group Inc.
Still, boards with more investing, finance and accounting experience may be better positioned to deal with today’s quickly evolving financial industry.
In the old days, every chief executive wanted a board that consisted of his mirror image, said Roman Weil, an accounting professor at the University of Chicago.
Now, it’s more important to have board members who understand risk.
Although a background in finance doesn’t guarantee that a director will possess this knowledge, the skills and experience often go hand in hand, Weil said.
Yet individuals with significant financial markets experience are largely absent from bank boards.
Of the 150 or so directors at the 10 biggest US banks, only 15 had investment experience, and only a handful had an accounting background.
The lack of such experience is especially striking at board audit committees, which are responsible for a bank’s financial statements.
At JPMorgan Chase and Co., for instance, the audit committee is made up of a former Congressman, a museum president and the head of a real estate company. Bank of America’s audit committee includes a retired general and a former admiral.
While these individuals may all be smart, sceptical, and not easily cowed, investors have to ask if they are best suited to referee, say, an argument between the chief financial officer and the bank’s auditor over what portion of loss on a mortgage-backed security is due to an actual credit impairment versus losses due to temporary market conditions.
At some point, boards need expertise that allows them to go toe to toe with the people and businesses they oversee.
To get it, banks have to lift the velvet rope and let more people into the off-limits boardroom club.