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Why lenders should care about corporate governance

Controls and oversight keep the bank's eyes on the compass

There's been a lot of heat generated over whether the roles of board chairman and chief executive officer should be split. Frankly, I think it's probably a good idea--though there's hardly a consensus behind it either within or outside of the banking industry. And how banks make decisions about such issues in the corner office and the boardroom makes a difference to the credit function.

Directors are supposed to govern the enterprise. That's different than managing it, though there are some common elements to each. Governance implies the use of principles by which an enterprise is operated consistent with expected outcomes over a period of time. Also implied is a certain independence of judgment and oversight over not only what is done but how.

A lesson from the oil patch

In this broad context, I recall an incident that occurred when I was in a meeting with the CEO of the big energy bank in Midland, Texas, that collapsed in 1983 when oil prices swooned dramatically. Before the decline set in and while prices were increasing relentlessly, the CEO interrupted our conversation in his office one day to take the call of an outside director.

The director, a successful independent oil man, was leaving on a business trip the next day and wouldn't be back until just before the bank's next board meeting about a week later. Before leaving town, he wanted to know if the chairman and CEO needed help on anything before the next meeting. The side of the conversation I heard was cordial and unremarkable. The director seemed concerned, involved, and helpful.

In hindsight, the bank collapsed in part because we were relentlessly pursuing a strategy of preserving lending market share in a highly concentrated industry, energy exploration and production.

Was anyone at the board level expressing concerns to the CEO or to fellow directors that the concentrations of credit by size, purpose, collateral and geography were excessive? 

Were the directors, largely an assembly of independent oil men, collectively comfortable with the way we were underwriting and monitoring credit?

As the bank's credit administrator, I voiced occasional concerns not so much at the concentration issues as at the apparent lack of formality in many of our processes.

As it turned out, our underwriting was reasonably sound and consistent.

In hindsight the real issue was that of concentrations in a variety of forms.

The other issues alone were not likely to have been sufficient to kill the bank.

This is analogous today to the concentrations so many community and smaller regional banks experienced recently in commercial real estate. It's not that the underwriting, credit by credit, was faulty. It's just that there was too much of the same product that choked the market, making credit performance very difficult and seriously depressing collateral values.

Did the Midland bank's directors have any sense of that? 

Did the Chairman and CEO fully discuss with the board the risks we were running? 

Do we know whether the board ever discussed concentrations as an existential risk to the bank? 

More to the point, would a separation of the duties of CEO and board chairman have facilitated any of these discussions and resulted in any modifications of strategies and operating priorities? 

We'll never know but the question is provocative even this many years later.

What's the job of the leaders and the overseers?

Our Chairman and CEO was bright, aggressive, experienced, and very much in charge. You'd have to be pretty bright yourself and very sure of your position before challenging him in any significant way.

It's not that he necessarily thought his way was the only way. He brought logic, engineering experience, and discipline to his job and he had a string of strong successes in his over 20 years of service with the bank.

He was also very persuasive.

CEO job descriptions pretty much say the same things. The incumbent is boss and will be judged by his overall success in discharging his responsibilities and in meeting and overcoming the challenges of making a business prosper and grow.

In this age of enterprise risk management, the basic question is how well informed the board is of the overall risk profile of the institution. The profile itself is a matter of judgment and discernment but it requires multiple inputs from a variety of sources. The process requires a thoughtful assessment by independent and reasonable experts of what is appropriate to the appetite of the ownership and the other constituents of the business.

If I am an outside director, how do my board colleagues and I get that sense of overall risk?  There are the traditional silos of banking business activity and each has its own set of risk metrics. What the board needs is a way to integrate those essentially unrelated assessments in a systemic way. How does a board function collegially but independently of the person in "charge?"

Values of independent chairmen

The purposes of an independent chairmanship are the related responsibilities to set the board agenda and to preside over periodic meetings of outside directors without the presence of the CEO or other inside directors. How can a board of outsiders be expected to have candid discussions on the performance of the CEO and the executive management in his presence?  How forthcoming would they otherwise be with their questions and concerns? 

In my days as CEO of an independent regional bank, before we were acquired by First Security Corporation, I functioned as president and CEO alongside a non-executive chairman. We were family-owned at that time and this man had a long and productive relationship with the family, something it would take me, as the newcomer, time to establish.

This chairman was an enormous help to me as he spent considerable time in helping the family absorb and assimilate our situation as regional business conditions deteriorated. This was especially urgent since the examiners had forced a management change-which had that resulted in my hiring.

As our situation gradually improved, the message of our return to health was credibly delivered by a person not conflicted in any way with the tone and tenor of the message. It was an enormous help to me not be second guessed nor micro managed by a concerned control group of the board.

The same logic and outcome would fit a situation where conditions were deteriorating and the board was concerned and unsure of the information it was receiving. This is not a reflection on the veracity of the CEO. But sometimes directors' concerns need to be taken off-line and examined in a more reflective and analytical way than within the time constraints of once a month meetings.

Two heads can be better...

I think it's time that the principle of a non-executive chairman be viewed as an important component of a bank's internal control systems, ranking in importance with the independence of the auditors or loan review.

Those of us in the credit function appreciate the role of independent "inspectors," including a committee of directors reviewing such things as past due trends, exceptions, and high-dollar exposures.

What the separation of chairman and CEO roles does is extend these otherwise familiar principles to other parts of the enterprise and facilitate the linking of exposures among business lines and activities.

Ed O’Leary

Banking Exchange Contributing Editor Ed O'Leary, a veteran lender and workout expert, spent nearly 50 years in bank commercial credit and related functions, working with both major banks as well as community banking institutions. His last job before retiring was as the CEO of a regional bank headquartered in Alburquerque, N.M. He earned his workout spurs in the dark days of the 1980s and early 1990s in both oil patch and commercial real estate lending. O'Leary began his banking career at The Bank of New York in 1964, and worked at banks in Florida, Texas, Oklahoma, and New Mexico. He served as a faculty member and thesis advisor at ABA's Stonier Graduate School of Banking for more than two decades, and served as long as a faculty member for ABA's undergraduate and graduate commercial lending schools. Today he works as a consultant and expert witness, and serves as instructor for ABA e-learning courses. You can e-mail him at [email protected]. O'Leary's website can be found at

In mid-2016 O'Leary's "Talking Credit" blog received a bronze excellence award for the Northeastern Region from the American Society of Business Publication Editors.

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