Sabine Lautenschläger: Good governance and the role of
supervisory boards
Speech by Ms Sabine Lautenschläger, Member of the Executive Board of the European Central
Bank and Vice-Chair of the Supervisory Board of the European Central Bank, at the Luncheon of
Chairs of Supervisory Boards of banks in Germany, Frankfurt am Main, 6 November 2018.
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What must a bank be able to do? As always, the answer depends on whom you ask. Bankers or
bank shareholders are likely to say that a bank must be able to make a profit. But as a supervisor
I would tell you that a bank must be able to manage its risks.
These answers do not contradict each other. A bank that can't make a profit will fail, as will a
bank that does not properly manage its risks. So the real question is what each of us should
focus on.
What's the focus of supervisory boards? What do you yourselves focus on? In a sense, you are
caught between two stools. On the one hand, you are bankers. On the other hand, you are also
supervisors.
Supervisory boards play a major role in managing risks. They contribute to the checks and
balances that every bank needs. They are a core element of good governance.
And we have high expectations of you and of what you can do to make your bank more resilient.
We expect supervisory boards to assess and oversee the work of management bodies -
independently and thoroughly. Most of all, they have to ensure that strategic decisions are always
based on a sound analysis of risks. In this regard, you serve as the management's good
conscience.
In a nutshell, this is what supervisory boards should do. Whether they really do it, whether they
are able to do it, depends on many things. It depends on individuals and it depends on structures.
Those who chair a board, who are members of board committees or who interact with internal
control functions need to be available and possess the right knowledge and experience, not only
to meet today's needs but also tomorrow's challenges.
In our view, supervisory boards still have some room to improve, particularly with regard to their
collective knowledge. Assessing and overseeing management bodies requires ever more
technical knowledge. Just think of digitalisation and IT, of internal models or new rules. While no
one expects every individual board member to be an expert in all of these areas, the collective
knowledge of the board needs to be well-balanced.
And it's not just the quality of board members, it's also the number of them. If too many people
are around the table, it's hard to have sensible debates and take sound decisions. In this case,
too many cooks can indeed spoil the broth. This is particularly relevant in times of crisis when
there is little time to take decisions. And we still see boards with too many members - also here
in Germany.
And it's also about how the board is integrated into the bank, with independence being the
keyword.
The European Banking Authority, the EBA, has issued very clear guidelines requiring supervisory
boards to have a sufficient number of independent members. I fully support this very important
point. Only those who are truly independent can challenge and influence the decisions taken by
management bodies.
Among other things, the EBA requires that board members have no material financial or
business relationships with the institution itself. Likewise, members should neither be a
controlling shareholder of the institution nor represent the interest of a controlling shareholder.
So, it's about formal independence.
All in all, European banks have seen an increase in the number of formally independent board
members over the past few years, even though some banks lag behind.
In Germany in particular, supervisory boards and shareholders are prone to doubts and
misunderstanding in this respect. What do supervisors really expect as regards independence?
We know that, unlike in many other countries, there is no legal duty in Germany to have
independent board members. And that is a pity.
So we cannot enforce anything in that regard, but we can still express our expectations. We
expect supervisory boards to have a "sufficient" number of independent members because that
is part of good governance. What is deemed "sufficient" depends on the individual case, of
course, and it follows the principle of proportionality.
German banks would in any case not violate the law if their supervisory boards had more
independent members. Banks and shareholders would even benefit from stronger checks and
balances, more diversity and new perspectives, which would help to counter the risk of
groupthink.
But it's not just about formal independence. Board members also need to be independent
thinkers. Only then can they form their own opinions and exert their own judgement. Even though
boards must take decisions as one and stand for them as one, each member must be able to
defend their own view in discussions.
The supervisory board is a core element of good governance and risk-oriented management. But
it's not the only element.
The frame that a bank builds around the risks it takes - the risk appetite framework - is equally
important.
The risk appetite framework comprises the principles, processes, internal controls and systems,
as well as the responsibilities and the limits of material risks that the bank wants to take on or
has already taken on. And, of course, the supervisory board plays an important role in building a
sensible risk appetite framework.
Over the past few years, banks have made good progress in designing their risk appetite
frameworks. Still, there is scope for improvement. Even though risk appetite frameworks now
cover many more types of risk, one category is often overlooked: non-financial. Reputational
risks, IT risks or legal risks are often either not covered at all or just in part. I know that it's difficult
to measure these risks, but neglecting them is no solution either.
Once the risk appetite has been defined, risk limits play a major role. They ensure that the risks
taken are in line with the risks defined; they make the risk appetite operational. It is important that
banks break down these limits by business lines, entities or countries. Not all banks do that. And
when they do, the local limits are not always consistent with those at the consolidated level. This
is something banks need to work on.
Another problem is that banks often set the limits so high that they are no of help in steering risk
taking. It is obvious that this puts the entire risk appetite framework in question.
Building a sensible risk-appetite framework is not that easy. And it's not enough to just build one;
it also has to be applied. That's the crucial point. Banks must turn the risk appetite framework
into a key element of their risk culture and their decision-making.
What does that mean? It means that all parts of risk management must be precisely aligned to
each other - including the risk appetite frameworks. And they must be aligned to the rest of the
organisation as well.
What good is a well-defined risk appetite if the remuneration schemes set different incentives?
What good is a well-defined risk appetite if it's not finely-tuned to the business model or the
business strategy?
In our view, too many banks still see their risk appetite framework as a separate tool. It is not. It
must become an integral part of decision-making. Most banks do not use the defined risk
appetite to facilitate discussions at all levels of the organisation. This, too, they must change.
These are a few of my thoughts on the topic of governance and the role of supervisory boards.
Now I am looking forward to having a discussion with you.
Thank you for your attention.