The Clearing House Association Issues Draft Governance Principles

The corporate governance of banking organizations has become the focus of intense examination in the wake of the financial crisis. Because of the complexity that surrounds both the causes of the financial crisis and the weaknesses and vulnerabilities it exposed in the banking system and financial markets, it is manifestly unreasonable to suggest that better corporate governance practices at banking organizations alone could have prevented, or even substantially ameliorated, the crisis. That said, good corporate governance, including a well-functioning board of directors, is critical to a financial institution’s ability to manage its risks prudently, while operating profitably and contributing to economic growth.

In recognition of the importance of good corporate governance in the banking system, the Clearing House, an association comprised of some of the world’s largest commercial banks, has developed and submitted for public comment its Guiding Principles for Banking Organization Corporate Governance (the “Guidelines”). These principles focus on the role of the board of directors, as a cornerstone of the governance structure.

The U.S. banking system is unusual in that banking organizations in the United States, especially larger ones, are typically organized in a bank holding company structure. There is a holding company, organized as an ordinary business corporation, as the top-tier entity, which in turn owns one or more commercial banks and other operating subsidiaries. The Guidelines address governance at both the top-tier entity and bank subsidiary levels, but recognize that many risk management and governance issues may be best addressed on an organization-wide basis at the top-tier entity level.

The corporate governance considerations applicable to banking organizations are somewhat more complex than those applicable to many commercial and industrial firms. Like other corporations, the fundamental source of the corporate governance arrangements for a banking entity is the law under which it is chartered. In the case of the bank holding company itself, this is a normal corporate statute, such as the Delaware General Corporation Law. In the case of a bank subsidiary, however, the charter statute is a specialized banking statute, which incorporates provisions deemed appropriate for banks.

Moreover, banking organizations are subject at all levels to a plethora of regulations, many of which directly affect important governance issues, such as board committee structure and composition, affiliate dealings, the frequency of board meetings, compensation, director and officer indemnification, and director independence. The governance of banking organizations and the functioning of their boards are also affected by the nature of the prudential supervision of the banking industry, which entails an active interaction between supervisors and the institutions they supervise, in which the board plays a key role. An important function of the Guidelines, in my view, is to collect and lay out many of the regulatory requirements and statements of regulatory policy that inform bank corporate governance.

In today’s bank regulatory environment, there is a continuing escalation of the already significant requirements placed by regulation on the board to perform specific tasks, such as reviewing or approving specific policies, many very specialized and detailed. The imposition of too many, and too detailed, requirements on the board can actually impair the board’s ability to function effectively in an independent oversight role, addressing the core issues facing the banking organization. The Guidelines deal with the need to strike the appropriate balance and to preserve the distinction between active board oversight and day-to-day management.

Although I am clearly biased given my role in advising those who prepared the Guidelines, I believe they represent a balanced and thoughtful effort. They recognize that banking organizations differ among themselves in a number of ways, including in their businesses and structures, and as a result there is not a “one size fits all” formula for their governance. But aside from one’s view of their merits, by the very act of producing the Guidelines and submitting them for comment by the public, academia and the regulatory community, the Clearing House has taken, in my view, an enormously important step in advancing the discussion of how to achieve the appropriate balance in the corporate governance of the banking organizations so central to the economy.