The Pressures of Modern Governance for Banks

Nicholas J Price
5 min read

Banks continue to be scrutinized by shareholders, regulators and the public. Many eyes are watching to see if boards and executives are making wise decisions. Old reasons exist for those pressures to continue and they’ve been compounded by some new ones. Bank failings have a huge impact on the overall economy. When customers lose money, they lose their confidence in banks and it’s very difficult to regain their trust. Banks are just now beginning to make a rebound after a large number of failures. Boards of banks still have plenty of old and new pressures, including profitability, loss, fraud, cybersecurity and risk management.

Modern governance brings even more expectations. Bank board directors are expected to ask the right questions to get the right answers at the right time and to make the best possible decisions for their shareholders and customers. That’s a tall order with so many pressures looming overhead.

Shareholders and Stakeholders Haven’t Forgotten Recent Bank Failures

Americans enjoyed a long period of bank stability during which bank failures were rare. Financial experts have said that the banking industry had a silent canary in the coal mine between 2004 and 2007 when not one of the 7,000 banks failed for 32 consecutive months. Some say that should have been a sign that trouble was ahead. Everything changed in 2008.

When the financial crisis hit, 25 banks closed. It was the steepest increase ever. Bank failures continued and 140 banks closed in 2009. The number of bank failures topped out at 157 in 2010. By 2011, the number of bank failures finally began to decline, dropping to 92. The number of bank failures didn’t hit the single digits until 2015. At the peak of the crisis, banks lost over $373 million.

Big Bank Losses Concern Shareholders, Regulators and Customers

Most banks had a terrible year in 2008. The top 12 largest losses came in America and Europe, and four of them occurred in Germany. Three of the largest losses came from banks in Switzerland and Belgium, which are small countries. If we count the combined losses of The Royal Bank of Scotland, Citigroup and Wells Fargo, the loss was over $160 billion.

Most recently, Deutsche Bank in Germany disclosed a net loss of $924 million for the 2019 third quarter. The loss was substantially larger than the $865 million that was projected. This was the second quarterly loss for Deutsche Bank, and the losses occurred during a restructuring plan that caused 18,000 layoffs. The losses triggered a drop of 7.9% in the company’s closing share price. Deutsche Bank plans to leave equities trading and focus on long-term strengths.

Low Interest Rates Are Impacting Profitability

Currently, around 60% of banks aren’t generating returns on equity, which could worsen if there is another major financial downturn. The decline in the economy has caused some of the lowest interest rates we’ve seen in decades. Low interest rates constrict bank profitability, adding pressure on the margins. A rise in interest rates would mean that banks would have more money to lend to their customers.

Banks haven’t been able to support the rapid growth of tech companies, so some tech companies have taken matters into their own hands. Revolut and Apple have now entered the banking industry. According to McKinsey, fintech companies are investing over 70% of their budgets on innovation and invention strategies, which is double what regular banks invest in the same area.

Risk Management Continues to Challenge Banks

In recent decades, the complexity and fast pace of the financial sector have made it difficult for the banking industry to put together strong risk management plans. The biggest risks demand heavy board attention. Some of the greatest risks that banks are facing include:

  • Credit risks from loans
  • Risks associated with trading activities
  • Liquidity risks due to unequal liabilities and assets
  • Errors and omissions in core systems and processes that affect operational risks
  • Risks pertaining to writing insurance contracts

Cybersecurity Continues to Place Pressure on the Banking Industry

Bank boards are better educated on cybersecurity matters than in the past. That’s all the more reason to keep strong oversight on cybersecurity measures. Boards will continue to deal with issues including unencrypted data, malware, non-secured third-party services, spoofing and data that’s been manipulated by hackers.

Cybercriminals continue to gain in their sophistication and knowledge of technology. Bank boards and their IT teams will continue to face pressure to stay ahead of cybercriminal activity.

Fraud and Money Laundering Problems Keep the Pressure on Banks

There is also pressure on large and small banks to prevent fraud and money laundering. In the 1980s, the Bank of Credit and Commerce International (BCCI), the seventh-largest financial institution in the world, fell prey to illegal dealings with Saddam Hussein and Manuel Noriega. In 2013, the Liberty Reserve Bank laundered around $6 billion for criminals in the largest money-laundering case ever discovered.

Smaller, regional banks are even more vulnerable to money-laundering schemes than the big banks. Criminals count on the fact that smaller banks don’t have abundant funds to invest in technology and processes to deter crime. They’re often right. For example, Jonathan Robert Quaccia did time in federal prison for laundering over $2 million in an illegal marijuana distribution scheme in Oregon. He used a handful of people in several different states to make deposits of under $10,000, which helped detract attention from his scheme.

Smaller banks are at risk for such schemes. The effects of such criminal activity destroy consumer trust in the banking industry over the long term.

Advanced technology has led to modern governance, which is the practice of empowering corporate leaders with the technology, insights and processes that are required to fuel good governance. Bank board directors are challenged with getting the right information at the right time to prevent all the risks that have caused such intense scrutinization of the banking industry. Diligent Corporation is an industry leader in board management software programs and systems to support modern governance principles to help bank board directors manage the multiple pressures they deal with on a continual basis. Diligent’s products bring bank boards one step closer to regaining the trust that’s been lost in the banking industry in recent decades.