Schroders: Banks - a new approach to risk?

We researched and engaged with a sample of European (and a few US) banks with the aim of identifying best practice in these areas in order to identify those most likely to preserve shareholder value over the long term. The analysis focused on a limited number of indicators reflecting what we consider good risk governance and cultural change. 

These indicators include transparency around the board’s oversight function, the use of dedicated risk committees, the appointment of Chief Risk Officers (CROs) and the role of the Chief Financial Officer (CFO) and Chief Compliance Officer (CCO). We assessed how risk management was integrated into remuneration structures. We also considered the independence, capacity and effectiveness of the compliance and risk functions. 

We concluded that risk management regulations are not prescriptive enough in Europe to impose a good governance model. We believe that bank managements need to go beyond standard box-ticking exercises to ensure robust risk management.

The key issues we discovered include:

• A lack of risk management expertise. Historically, risk management has been under-resourced in the banking sector. This restricts boards’ ability to deal with unforeseen risks. It also limits CROs’ ability to implement the framework necessary to properly manage risk in large and systemically important organisations.
• The limited authority of CROs. We think the sector has yet to recognise the key role played by risk specialists.
• The high importance of non-compliance issues. Certain matters are beyond the reach of compliance departments yet are still critical to the functioning of the sector. These should be managed as risks, but many banks have yet to change their approach.
• The independence of control functions should be clarified and strengthened. Oversight needs to be as free as possible from management interference. As part of this process, banks should also be more transparent about how these functions are resourced.

Engaging with companies remains the best way of making banks aware that we as investors are increasingly paying attention to these crucial questions. Engagement also allows us to encourage best practice across the banking sector. Changing banking culture will take years, but we think that establishing good governance is the first step towards achieving this.

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