A bank director’s headache

Dr. Serebuor (not his real name) has been appointed as a director of one of the licensed Specialised Deposit Taking Institutions regulated by Bank of Ghana. In his case, it is a multinational bank reporting to dual regulators, and by extension, operates in a relatively strong corporate governance environment.

He admits that participating in various corporate governance programmes after his appointment has exposed him to the onerous responsibilities expected of a director under the new Bank of Ghana Corporate Governance Directives of 2019. He quipped during our discussions whether these responsibilities are commensurate with the related incentives available to directors.

He has been particularly concerned about the specter of jail term if directors are found culpable for the collapse of a financial institution. He also seemed perturbed that when found guilty of corporate malfeasance as a director, one could be debarred from directorship of any financial institution for a period of five years. This is in addition to the possible jail term where he joked about the absence of executive suites in the prison network.

On my part, I assured Dr. Serebour, that being appointed a bank director is a reflection of his profile and the potential to add value to the growth of the organization. It is a noble stewardship that must not be seen only in terms of doom and gloom or what could go wrong. I had to remind him that there is a risk in everything, including the decision to do nothing.

He simply need to be honest, transparent, intellectually inquisitive and revert to what qualified him as a fit and proper person for the role. A few tips on how he can play his role effectively were discussed and shared below.

I needed to help him  per an analogy  that I am not a particularly good science student but common sense  and years of driving a motor car convince me that a healthy friction of parts of the  machine is necessary to ensure effective performance of the vehicle.

In the corporate space, similarly, I would encourage a healthy friction between the Internal Audit function, Risk Management, the External Auditors and management, headed by the Chief Executive Officer, as a necessary condition for effective governance of the organization. This would assure the directors that the various levels of defence mechanisms are poised for  growth and sustainability of their organization.

The Chairman of the Board Audit Committee who must ideally be an independent non-executive director, must tolerate a degree of friction which will compel all partners to engage in extensive due diligence. From this the Board Audit Committee will report on the health of the bank to the main board.

While it is not expected of the Board Audit Committee to dabble in extensive detail, it is still imperative that this committee’s deliberations are not clouded behind aggregated figures. The devil is in the details is a cliché that must be foremost on the minds of members of this committee.

Deceptive Aggregations

There have been instances where the marketable assets portfolio has been rising to give a false sense of security. The Other Assets line has also been noted in some cases to be a dumping ground for inappropriate facilities made to related parties. Delving into the make up of these portfolios may reveal a large chunk of toxic assets that are not as liquid or marketable as the name suggests.

If analysis merely ended with observing trends, the Board may wake up one day to find that in a liquidity crunch, the marketable assets portfolio could not be liquidated to create the buffer that it was originally intended to provide. In my personal experience I have been unimpressed about the growth of this portfolio in a certain firm at a time when it was borrowing heavily on an overdraft that was becoming hard core.

When quizzed about the economic sense in paying interest on the overdraft in excess of the returns on the marketable assets, it turned out that over seventy percent of that figure had been placed in another micro-finance institution which itself was bleeding profusely from illiquidity and on the verge of collapsing.

At the Board Audit Committee level, members must be inquisitive enough to ask for the breakdown of these aggregated figures in the balance sheet.

Similarly, details of the Top 10 or Top 20 Depositors and Borrowers, respectively, must be sought. Otherwise the true state of solvency may be missed, as one or a few clients on both sides of the balance sheet can drown the bank.

Drilling down of these figures is even more imperative in this covid 19 era where otherwise lucrative sectors of the economy have suddenly found themselves in unprecedented economic malaise.

The fortunes of the bank’s Top 20 Depositors would give an indication of the sectors likely to face difficulties which may imperil the bank’s funding sources. The Top 20 Borrowers may also impact operating profits from the large expected losses provisions that may be needed. The effect on Capital Adequacy Ratio computation may derail all risk appetite considerations.

Knowing the real compositions of these aggregated figures would determine the profile and therefore the adjustments necessary to be made in the risk appetite trajectory and a re-evaluation of certain operating costs.

Failure to adjust to the dynamics of the Top 20 Borrowers or Creditors can be detrimental to a financial institution’s health, in view of the concentration risks on either side of the balance sheet.

Every finance student is aware of the correlation between risk and return, where the higher the risk, the higher the expected return. This is not however absolute in view of the considerations that underlie the risk factors.  Various textbooks talk about the risk- free rate, usually in relation to sovereign instruments or rarely blue- chip companies.

We have all been witnesses to the challenges that Greece, Turkey, Portugal, Argentina and a host of other countries have been through in servicing sovereign instruments.

That an instrument is risk free and subsumed in the aggregated assets is cold comfort. Directors must be interested in the issuers of those instruments and must consider not only their past record of fulfilling obligations, but also the short to medium term capabilities going forward.

A case in point is the over concentration of a fund management company’s holding of Ghana Government Interim Payment Certificates, as if they were or are as liquid as cash.

The reality is that governments, past and present have delayed interminably in settling these obligations as and when due, on account of fiscal indiscipline. This is not a secret, nor peculiar to any specific Ghanaian government.

To continue to pile up these instruments and create assets out of these without regard to concentration risk smacks of poor risk management, which their regulator should not have lost sight of.

It is admitted that at the board level, directors do not have the luxury of digging deep into details of aggregated figures. It is expected, however, that the board audit committee will conduct such detailed analysis, especially where trends appear too rosy. A sudden spike in earnings must court greater scrutiny of the sources and sustainability of these returns. Nick Leeson in the Barrings Bank collapse is a case in point.

Proof of the veracity of any unusual figures must be obtained. The collapse of the German fintech company – Wirecard in June 2020 after admitting that Euro 1.9 billion of cash did not exist , but had been signed off by the firm’s external auditors , Ernst and Young is a typical justification for asking for and obtaining proof of any “wild” figures in the balance sheet.

An accountant friend upon hearing of this case, expectedly referred to the standard contract where the external auditors are supposed to be engaged in routine audits. They are quick to escape blame by saying that if a firm requires a forensic audit the contract must specifically state this.

All these go to confirm my director friend’s anxiety about who to trust.  As a board member, he is assuring all stakeholders that the financials, to the extent that they have not been qualified, represent the firm’s true state of health.

Board members in exercising their supervisory functions, cannot be expected to be magicians in identifying frauds or misrepresentations. They   can as individuals and collectively be inquisitive,  and ask pertinent questions . When in doubt, they can seek expert external advice, document the responses from these experts and allow external auditors the free hand to drill down potential frauds and compliance issues, even if these will create tension between internal/external audit and management.

When it gets to round two (ie the board is sued individually or collectively), at least they can count on some impartial judge or arbiter, given the transparency and due diligence exhibited, even if the firm collapsed as it did in the Enron and Wirecard cases.

The writer is a Fellow of the Chartered Institute of Bankers, an adjunct Lecturer at the National Banking College, a farmer and the author of “Risk Management in Banking” textbook.

Email; [email protected]  Tel. 0244 324181 / /0576436414

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