Fair Game: The Fed Wants to Make Life Easier for Big-Bank Directors

Fair Game

By GRETCHEN MORGENSON

Amid reports Thursday that Stephen Sanger, chairman of the Wells Fargo board, may step down in the coming months, all eyes are on the bank’s directors and their oversight of the troubled institution.

While some Wells Fargo shareholders are urging the bank’s directors to sharpen their scrutiny in the wake of continuing misconduct, it’s noteworthy that new regulatory guidance put forward by the Federal Reserve Board, the nation’s top financial regulator, would go in the opposite direction. In essence, the Fed says, big-bank board members need to take a load off.

After a multiyear review, the regulator concluded that excessive regulatory duties are hobbling bank boards and distracting directors from the more important work of guiding bank strategy and adopting effective governance at their institutions.

And it proposed guidance to fix the problem. Unfortunately, this proposal — which could go into effect after a 60-day comment period — is very likely to reduce crucial interactions between bank examiners and bank boards, current and former bank regulators say.

Intended to lighten a regulatory burden, the Fed’s idea could result in less information for directors about problems that government overseers have uncovered at an institution. And the reduced board involvement would give more leeway to bank executives to tackle regulatory flaws quickly — or not.

As disclosures about fresh improprieties at Wells Fargo stream in, now seems an odd time to reduce communications between regulators and bank boards. In recent weeks, Wells has been forced to disclose that it pushed auto insurance on customers who did not need it, that it failed to refund insurance money owed to people who paid off their car loans early and that the number of fraudulent accounts created by its staff was likely to “significantly increase” from the 2.1 million that the bank had previously estimated.

The Fed is not the only government entity that thinks bank directors are under duress. A recent report from the Treasury Department said that regulators’ expectations of bank boards should be reformed “to restore balance in the relationship between regulators, boards and bank management.”

The Fed’s recommendations are the result of work that predated the Trump administration, but they certainly dovetail with its broad deregulatory agenda. In 2014, Daniel K. Tarullo, a former Fed governor, outlined the need for change in this area. He resigned from the Fed in April.

The new Fed guidance is emerging as bank directors say they are overwhelmed by minutiae in their jobs. They often blame heightened regulation required by the Dodd-Frank Act, the law that aimed to forestall a future financial crisis.

A Fed spokesman declined to comment on the proposal; the agency has asked the public to submit views on the concept.

Here’s what the Fed wants to change: Currently, its examiners report all regulatory matters requiring corrective action to a bank’s board as well as its senior management. As the Fed explained in 2013, “communication of supervisory findings to the organization’s board of directors is an important part of the supervision of a banking organization.”

Now the Fed seems to view such findings as too much information for bank directors.

So, under the proposed guidance, it will be up to senior management to keep the institution’s board apprised of its efforts and its progress to remediate matters requiring attention. Such matters would only be directed to the board for corrective action when senior management fails to take appropriate remedial action or when the board needs to address its corporate governance responsibilities, the Fed said.

The guidance would “clarify a board’s roles and responsibilities in the supervisory process and more efficiently allocate its time and resources,” the Fed said when it released the proposal.

Under ideal governance circumstances, of course, managers manage effectively and boards supervise closely. And, to be sure, every minute a director spends on trivia means one less minute for critical oversight.

But while bank boards may trust their managers, directors must also be able to verify.

The Fed is careful to say that boards of directors would still be responsible for holding senior management accountable for fixing supervisory flaws. But that task could be more difficult when directors aren’t aware of the findings.

Sheila C. Bair, a former chairwoman of the Federal Deposit Insurance Corporation, said she thought it was positive that the Fed was trying to clarify lines between a bank’s board and its management. But, she said, the rule proposed by the Fed is flawed.

“Leaving to management the decision to share supervisory findings with the board strikes me as problematic,” Ms. Bair said. “I think bank examiners feel their findings have more weight with management when the board is also in the loop.”

Since Mr. Tarullo left the Fed, Jerome H. Powell, a Federal Reserve Board governor who is head of its bank oversight committee, has spearheaded the changes for bank directors. “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 told an audience in Washington in April.

An array of regulatory issues could be affected by the Fed’s proposed rule. They include matters relating to how a bank values its loan book or how it provides for losses, succession planning and risk management practices.

Trouble is, even the best-managed banks make regulatory stumbles that should interest their directors. For example, a 2014 study by the F.D.I.C. found that over the four years ending in December 2013, almost half of F.D.I.C. examination reports on satisfactorily rated institutions contained at least one matter that required attention from the bank’s board.

Although the F.D.I.C. supervises smaller banks than the Fed does, its findings were telling. Most of the matters requiring board attention — 70 percent — pertained to the institutions’ loans, the study showed. These included proper valuations and appraisals and matters involving troubled debt restructuring. Almost 30 percent of the loan-related matters involved the need to correct deficiencies in loss allowance methodology for loans and leases.

The second largest category of items requiring board attention was board and management oversight, the F.D.I.C. said. Problems included banks that didn’t have an audit plan that reflected the institution’s risk profile and entities that needed increased board or management oversight of their audit functions, better strategic planning and improved oversight of operational weaknesses.

The F.D.I.C. concluded that 80 percent of the time, bank managers satisfactorily addressed issues the regulator had cited. “Management’s and directorates’ willingness and ability to effectively address weaknesses and risks are critical to the financial health of the institution,” the study’s authors concluded.

Ms. Bair, the former F.D.I.C. chairwoman, suggested that the Fed change its proposal to keep the lines of communication open between examiners and bank directors.

“If the board is accountable for management remediation of supervisory findings, the board needs to know what those findings are,” she said. “On the other hand, boards shouldn’t be directly involved unless the findings relate to governance. If that is the distinction the Fed wants to make clear, perhaps a better approach would be to address the letters to management, but copy the board or, at least, the risk and compliance committee.”

During the mortgage debacle that began about a decade ago, we learned just how little some bank directors knew about the looming problems at their institutions. Financial regulators failed in their watchdog roles as well. While those events are behind us and banks are healthier now, reducing the information flow between bank boards and their examiners just doesn’t seem smart.

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