The global financial crisis had at its heart a failure of governance and oversight. Controls were ineffective, non-executives did not challenge and relationships broke down with regulators.

Boards have been slow to recognise the significance of culture. A survey conducted by Board Agenda and Mazars last year found that 63% of boards exclude culture from formal risk considerations. Meanwhile, respondents identified that “setting the right tone from the top” was the best way to influence culture.

Since the crisis the boards of financial services firms have taken a number of steps to ensure they are more effective and to atone for the mistakes of the past. But with the burden of greater regulation, unprecedented levels of technological change and fears over how well the industry is prepared for the next downturn—rather than solving the problems that caused the previous one—boards need to ensure they possess the right characteristics to be effective.

They must understand the vital role they play in setting the entire culture, vision and values of an organisation, while ensuring a sustainable return for all of its stakeholders.

“An effective board is all about having the right people working together in an effective manner,” says Anthony Carey, head of board practice at Mazars. “There needs to be the right level of support and challenge for them to thrive.”

Complex structures

More than ever, financial services firms must be aware of the broader set of stakeholders they serve. The bank bailouts mean politicians and the wider public wield a far bigger influence with regulators over how banks behave. A shifting and more intense regulatory landscape has forced firms to adopt more complex structures.

The Balkanisation of bank regulation means banks face increasingly localised governance requirements. In the UK, for example, banks have been forced to ring-fence their deposit-taking operations from riskier investment banking businesses, requiring them to have separate boards and governance structures.

Boards must demonstrate that they have a programme to meet increased regulatory requirements, often having to duplicate in multiple jurisdictions. Balancing local governance and global oversight is key, but an effective board has to set the fundamentals of a company’s culture, strategy and vision.

“Everything flows from this,” says Carey. “If the board understands the culture, it can ensure the organisation plays to its strengths. And it must be active in monitoring the culture which exists, and overseeing the implementation of programmes to close gaps between the desired and actual cultures.”

The essence of good corporate governance is ensuring trustworthy relations between the corporation and its stakeholders. According to Carey, a constructive relationship between the CEO and chairman is pivotal to an effective board, and a healthy board culture is one where there is a high level of both challenge and support.

The board must also ensure that the strategy fits the culture, and that the business makes a financial return in a sustainable way. Effective boards must balance risk-taking and entrepreneurship. This has become a top priority in recent years for banks in particular, as they have bolstered their risk functions. This has made them safer than ever but at the same time they must keep an eye on innovation and entrepreneurship in order to keep up with rivals.

“Excessive risk management can cause an organisation to become too bureaucratic,” says Carey. “Boards that are very adept at oversight of a steady-state environment must ensure they have the right tools and expertise to cope with today’s fast-changing environment and with a potential crisis.”

Sufficient diversity

There needs to be the right balance between executive directors and non-executive directors (NEDs) to enable the board to work effectively, and there should be no dominant individual on the board controlling decision-making and blocking challenge. There needs to be sufficient diversity among board members to avoid “groupthink”.

“Diversity in terms of gender and ethnic background is very important, but so too is diversity in terms of industry and/or professional expertise,” says Carey. “Regular board reviews will help ensure they have the right blend of expertise.”

Diversity is also vital as it relates to personalities and professional backgrounds. According to Carey, externally facilitated board effectiveness reviews enable boards to stand back and assess their strengths and areas for development through an independent lens, and to identify the changes that will enable them to achieve their full potential.

Boards have a basic responsibility to ensure sustainable long-term value creation through setting the strategy and providing oversight regarding management decisions, as well as selecting and changing the management when necessary. A long-term view is essential at a time when many European banks remain in a state of strategic flux, having changed their top executives a number of times in the past decade.

Deutsche Bank has had five different CEOs in the past 10 years and continues to grapple with a restructuring. Effective boards take a longer-term view, looking beyond the next set of quarterly results.

This applies equally to talent management. The churn at the top of big banks has an adverse effect on human capital. Too often the appointment of a new chief executive will lead to a clear-out of the previous regime. Sometimes this is welcome, but when it happens too frequently, it breaks continuity and undermines succession-planning.

Upheaval in the executive suite is often caused by conflict over strategy and culture.

Carey says: “An effective board sets the strategy and provides strong oversight, as well as establishing a culture that sets the right tone from the very top of the organisation. Without these elements, problems will persist.”

Or, as Andrew Bailey put it in his valedictory speech as head of UK regulator the Financial Conduct Authority in 2016: “My assessment of recent history is that there has not been a case of a major prudential or conduct failing in a firm which did not have among its root causes a failure of culture as manifested in governance, remuneration, risk management or tone from the top.

“Culture has thus laid the ground for bad outcomes, for instance where management are so convinced of their rightness that they hurtle for the cliff without questioning the direction of travel.

“We talk often about credit risk, market risk, liquidity risk, conduct risk in its several forms. You can add to that hubris risk—the risk of blinding over-confidence.”

This article is an excerpt from the Special Report – Future-Proofing Financial Services . You can read the full report here