August 28, 2019
Credit unions play a vital role in the US economy, but they face increasing regulatory scrutiny, competitive pressures, heightened and complex risks, and a more diverse membership. All of these forces must be carefully managed under the supervision of the board within a sound governance framework.
History shows that lack of effective governance and board oversight can lead to imprudent lending practices, nefarious activities, and/or unsound operating processes, all of which can lead to institutional failure. While ineffective governance and the resulting dangers are clearly not isolated to the credit union space, the Office of Inspector General for the National Association of Federally-Insured Credit Unions noted in its Material Loss Review reports on credit union failures that weak supervisory committee and board of directors’ oversight are typically significant factors.
A strong governance framework is no longer a nice-to-have. The increasingly complex operating environment requires it, stakeholders demand it, and regulators expect it.
As a first step on the path to increased oversight, we recommend that credit unions, like all financial services entities, take inventory of their governance framework. Has the institution articulated its goals and objectives, implemented a sound risk governance process, ensured effective management oversight, and measured the performance of the board and senior management? By asking a few questions, we can quickly evaluate the strength of a firm’s governance framework and the effectiveness of its board. We understand that governance is not one-size-fits-all, but by applying an industry-standard framework, our clients achieve better governance and stronger operations.
Governance is the Framework that Management and Boards Work Within
Corporate governance refers to the framework within which boards and executive leaders work collectively to build an effective and sustainable business operation. Corporate governance includes how the board and senior management, in their respective roles:
- Set the institution’s strategy, objectives, and risk appetite.
- Define the responsibilities and accountability of the board of directors, supervisory committees, management, and the staff.
- Establish the risk governance framework.
- Identify, measure, monitor, and control risks.
- Supervise and manage the credit union’s business.
- Protect the interests of depositors, members, and employees, as well as other stakeholders.
- Set a strong tone, articulating expectations that the credit union will operate in a safe and sound manner, with integrity, and in compliance with applicable laws and regulations.
- Ensure continued operations through management succession planning, disaster response, and crisis management.
Credit unions, like all financial institutions, are expected to operate in a transparent manner, comply with regulatory and prudential standards, and be held accountable to their members, auditors, and regulators. To ensure that these expectations are met, the board and senior management must be engaged, informed, and understand the workings of the institution and its lending and investment practices.
The board should be involved in the overall oversight of the risks, strategy, technology, regulations, business analytics, safety and soundness, and be aware of how each of these matters can affect the institution. A well-governed board should exercise knowledgeable oversight and objective judgment over management decisions, which involves engaging in discussions with senior management and, at times, challenging their recommendations.
Historically, as credit unions served a limited and defined group, members were active in the oversight of the institution. However, as memberships became more diverse, the members became less involved in the actual governance of the institution, leaving that to the board of directors and supervisory committees. Given that most credit union boards and supervisory committees are made up of unpaid volunteers, many have experienced difficulty attracting qualified and engaged board members. Uninterested and/or unqualified boards are less likely to ensure that effective governance is in place and that risk is properly managed.
Accordingly, a strong nominating committee of the board is highly recommended to facilitate active recruiting, board member education, self-evaluation, and succession planning to maintain a skilled and engaged board. While controversial, term limits also can be an effective tool to increase board diversity, ensure active participation, and prevent burnout. The challenges facing credit unions continue to shift and change. Consequently, to remain successful, boards must have the ability to learn, adapt, and embrace their role in governance and oversight.
To properly monitor the credit union’s operations, supervise the CEO, monitor senior management, and inform appropriate business objectives, credit union boards should have a solid understanding of the institution’s risk profile. In addition to evaluating the current financial conditions, boards must assess the riskiness of the business model, including the products and services offered, delivery channel, and the ability of the credit union to manage the risks associated with its business model and growth plans.
Risk management, also known as risk governance, is an important component of corporate governance. It includes the policies, processes, personnel, and control environment that collectively define how an organization manages risk. While a risk committee is not a regulatory requirement for all financial institutions, we recommend that boards convene a credit committee to be responsible for reviewing and approving lending policies, approving large loans, and monitoring risk exposures.
The formation of a skilled credit/risk committee to assess a member’s ability to repay a loan, and to form an opinion on the appropriateness of security for the loan, is an effective tool to manage risk exposures as well as borrower and asset concentrations. The knowledge gained through the oversight of a credit committee fosters a greater involvement of the board in evaluating and promoting a strong risk culture in the organization. In addition, it establishes the organization’s risk tolerance as conveyed through the risk appetite statement and management’s implementation of the risk governance framework.
It’s fair to say that a board or supervisory committee is only as effective as the amalgamated knowledge and understanding of its people, the defined framework in which it is designed to operate, and the commitment of each member. While some may see maintaining a higher standard of corporate governance as a costly proposition, an effective board leads to a higher-functioning credit union, which ultimately leads to reduced risk and a stronger financial position, allowing it to better serve its members. The rewards are certainly worth the effort.