131005 essential information neeed by members of the board of directors of banks

ESSENTIAL INFORMATION
NEEDED BY BANK DIRECTORS
GBRW Limited, London
October 2013
1GBRW Consulting. London

GBRW Limited is a financial sector consulting company based in London with offices in Washington DC
and Singapore. It trades under the name of GBRW Consulting. The company was established in 1995.
We advise clients worldwide at reasonable fee levels, drawing on international best practice.
This presentation was prepared by Jeremy Denton-Clark, Director as an aide to bankers in developing
economies. It is derived from seminars given to bankers and is not based on any country nor bank.
This presentation is purely descriptive, based on general international standards, and does not,
therefore, establish any legally nor contractually binding requirements nor obligations nor set any
precedents. Neither GBRW Limited nor Jeremy Denton-Clark accept any responsibility for the
consequences of any actions that banks or other institutions may take when implementing all or part of
the proposals in this presentation.
GBRW can be contacted on mail@gbrw.com or go to our website www.gbrw.com for further
information on this and other topics of interest to bankers in developing economies
London October 2013

MODULE 1
Ladies and gentlemen
This is a bank

What is a bank?
• A bank is a financial go-between between people who put money on deposit
with the bank and people who borrow money. The bank takes a turn in the
middle.
• A bank provides short term working capital loans to fund the gap between
customers paying their bills and stock being sold, thus a working capital loan
is self liquidating.
• A bank provides longer term loans to buy plant and machinery that is paid
back from increased production and thus profits. It is also self liquidating.
• A bank transfers money and exchanges money for other forms of money.
• A bank is a utility just as electricity and water companies are utilities. National
economics cannot exist without them.

Who are the stakeholders in the
bank? (in rough order of importance)
1. The current account holders and the depositors
2. The bond holders (long term lenders)
3. Creditors
4. Holders of Tier 2 debt
5. The shareholders (holders Tier 1)
6. Customers (loan portfolio)
7. The staff
8. The regulatory authority/banking system
9. The fiscal authorities

Why is a bank different?
• A bank borrows far more against its capital (8x its capital) than an industrial
company (maximum 1.5 x its capital).
• The foundations of a bank is the confidence placed in it by all the
stakeholders. Loose that confidence and the bank comes tumbling down.
• The liabilities of a bank are short term whilst its assets are long term.
A bank “borrows short and lends long”.
• A bank is a house of cards that can easily fall down.
• The banking system provides an essential service and cannot be allowed to
collapse (danger of systemic failure)

Ogden Nash
“ Most bankers live in marble halls
because they encourage deposits
and discourage withdrawals”
However, beware turning away from your physical roots , moving into
grander buildings and changing your culture e.g. from retail to
investment banking.

Module 2
The role and responsibilities
of the Board of Directors

The limited role of shareholders
1. To appoint and remove the members of the Board of Directors
2. To approve their salary and bonus (this isn’t always transparent)
3. To appoint the external auditors
4. To approve changes in the share structure of the bank that are
outside the normal course of business.
5. To approve changes to the charter of the bank.
6. The shareholders receive the Annual Report, a synopsis of the
strategy and can ask questions at the general meeting but this
is for information not decision making
Shareholders have rights but a limited
role in influencing the bank
9GBRW Limited, London

The role and responsibilities of the
Board of Directors
1. GUIDE the executive of the bank. Mainly through:
Development and delivery of the Risk Appetite of the Board
The approval of the strategy of the bank.
Ratification of the loan policies of the bank.
Discussion at Board meetings where senior executives are present
2. APPOINT AND DISMISS members of the Board of Management, including the CEO, to whom all executive
responsibility has been delegated. Set their salaries and bonus scheme.
Appoint and dismiss the head of the Internal Audit Department (and the Company Secretary).
3. MONITOR AND EVALUATE
The actual performance of the bank against budget
The control system of the bank.
The members of the Board of Directors are, in most jurisdictions,
personally responsible for the safety, control and governance of the bank. They can be sued or
even sent to jail (it is thus sensible for them to have Directors and Officers Insurance)

How can directors fulfil their role and
responsibilities?
• Directors need to be knowledgeable, well informed and active in
overseeing the management of the bank (they will be helped in this by the
Company Secretary (see separate GBRW presentation on the role of the
Company Secretary).
• This means they need a basic understanding of the business of banking
and what they need to look at when overseeing a bank and what control
instruments are at their disposal.
• To give them these basic knowledge tools we are using the CAMELS CAR
system

What do directors need to
understand?
Capital How much capital does the bank need?
Assets Is the loan portfolio safe and secure?
Management Is the management doing its job?
Earnings How does the bank make its money?
Liabilities Is the funding and liquidity secure and reliable?
Strategy Does the bank have the right strategy?
Compliance Is the bank wholly compliant with law and regulation?
Audit Are they really doing their job?
Risk Can they act truly independently?

13
Typical Board Structure
Board Of Directors
Chairman
Board of Management
Chief Executive Officer
Audit Committee
Nomination Committee
Credit Committee
Risk Committee
Remuneration Committee
Assets & Liabilities Committee
Chief Internal Auditor
External Audit Senior Partner
Chief Compliance Officer
Chief Risk Officer
Chief Financial Officer Chief Risk Officer
Full voting members
Not a member, but attending
Structure/governing body
Tools >> Commitment >>>> Disclosure >> SH Rights & Stakeholders
Intro >> What is and Why CG >> No CG? >>>Troubleshooting

14
Typical composition of the Board of Directors
Non-executive Chairman
Non-executive /
independent Director
Non-executive /
Non-executive /
Non-executive /
Head of Retail Services Head Corporate Banking
Chief Executive OfficerExecutive Directors
Non-executive/ independent Directors
Chief Financial OfficerCompany Secretary
In attendance

The committees of the Board of
Directors
• AUDIT COMMITTEE: has to be entirely independent of the executive, professional
and informed membership. This is not a sinecure. It is responsible for ensuring that
the figures reported by the bank are 100% accurate. See Module 10.
• RISK COMMITTEE: looks at risk policies at the macro level. It does not consider
individual credits, that is the job of the executive. Makes final recommendations
on specific provisions to the Board of Directors.
• NOMINATION COMMITTEE: recommends appointments to the Board of Directors
and the Board of Management. Should establish a standard methodology and use
a recruitment agency to avoid any charge of patronage and favouritism. There is
no “Right of Succession”. See Module 5.
• REMUNERATION COMMITTEE: recommends salary and bonus schemes of the
Board of Management to the Board of Directors, as well as payments to the Board
of Directors (all of which should be disclosed in the Annual Report to
shareholders).

The Chief Executive Officer and the
Board of Management
• The executive of the bank implement the policies and guidelines set by the Board
of Directors – they act according to instructions and are the servants of the Board
(this means the Board of Directors carry all the responsibility for everything that
happens in the bank).
• All executive authority has been delegated to the CEO and the Board of
Management by the Board of Directors.
• The executive are solely responsible for the day-to-day running of the bank.
• They are a team and the CEO is the primus inter pares “First amongst equals”
leading and developing the executive team.
• The CEO is primarily responsible for the development of the 5 year Strategic Plan
and the 1 Year Business Plan, the efficient operation of the bank and the bank
meeting its targets.

17
The Board of Directors - at the Heart of the Bank
and Corporate Governance
Providecapitalto
Actininterestof
Are accountable toElect and dismiss
Shareholders
- The annual general assembly -
Board of Directors
Board of Management
- The management team of executives -
Report and answer toGuide and control
The relationships between the main governing bodies
Intro >>

18
EXECUTIVE BOARD
Treasury & Trading Group
Chief Treasury Officer
Risk Management Group
Chief Risk Officer
Retail Networks Group
Chief Retail Officer
Operations Group
Chief Operations Officer
Wholesale Banking Group
Chief Banking Officer
Financial Group
Chief Financial Officer
SHAREHOLDER
BORAD OF DIRECTORS
Supervisory Committee
(Audit Committee)
Risk Committee
Normination Committee
Credit Committee
IT Steering Committee
ALCO
Relationships
Department
Products
Department
Marketing
Department
Retail
Department
Channel
Management
Department
Dealing Room
Department
Clients
Department
Credit
Department
Fiancial Institutions
Department
Market Risk
Department
Operational Risk
Department
Back Office
Department
IT
Department
Accounting
Department
Management
Reporting
Department
Property & Services
Department
Financial Control
Department
Internal Audit
SALES RISKTRADINGDISTRIBUTION ADMINISTRATION ACCOUNTING

Module 3
How much Capital does a
bank need?

The role of capital
• Represents the shareholders investment and increases with successful
operations and decreases when there are losses.
• The problem with banking is that the cost of the liabilities is known down
to the last cent. The value of the assets (apart from cash which is an
expense) is never quite so certain.
• Capital is the cushion that protects the bank against unanticipated losses
and declines in the value of the assets.
• Remember: banks have little capital and a lot of liabilities, this usually
leaves hardly enough room for error.

Capital Adequacy Ratios
• Regulators will establish a minimum Capital Adequacy Ratio (CAR) which is
the amount of capital expressed as a percentage of total assets (total
assets are adjusted to reflect the amount of risk in each category of asset).
• The usual CAR is 8% but many regulators will require a much higher ratio
of up to 12%
• It is important for banks to show a higher CAR than the minimum
required by regulators. Maybe 2% higher.

DANGERS
• The CAR can easily slip close to or below the minimum required by the regulator as a result of
losses or over expansion of the loan portfolio. Be careful even if you slip to within 1% of the
CAR.
• The reaction of the regulator is usually very negative and will require immediate action, this
often means reducing the assets of the bank which will adversely effect competiveness and
profits.
• Any deductions in the calculation of the CAR i.e. lending to insiders, are very expensive in
terms of lost profitability. Lending to companies controlled by shareholders can be seen as
giving back to the shareholders the capital they have invested in the bank

Structure of capital and its cost
• Capital is divided into Core or Tier 1 Capital and Supplemental or Tier 2
Capital.
• Tier 1 capital consists of capital paid in by the shareholders, reserves that
are not allocated against losses and accumulated profits that have not
been paid out to shareholders.
• Tier 1 capital is interest free money for the bank but in reality it is very
expensive as it is on capital that the Return on Equity is calculated. The
lower the capital the higher the Return on Equity.
• Tier 2 capital is mainly subordinated loans. As it is a loan the bank has to
pay interest on it. As it is subordinated to all depositors and creditors it is
more expensive (maybe 3%) than any other deposits

Discussion topic
How can the bank, under pressure from
the regulator increase its Capital
Adequacy Ratio?
GBRW Limited, London 24

The benefits of issuing subordinated
loans
• The rules are that Tier 1 capital must make up at least 50% of a bank’s total
capital (thus restricting the use of Tier 2 capital).
• Tier 2 capital must be issued for a period of greater than 5 years.
• The great advantage is that Tier 2 capital can be considered as capital when
calculating the CAR but it is not capital when calculating the Return on
Equity or paying dividends. Banks can have their cake (additional capital) and
eat it (not pay a dividend on the subordinated loan)
• The Tier 2 capital is subordinated to creditors and depositors (in liquidation it
is paid after they have been paid). It is thus more expensive.
• The higher the level of Tier 2 capital, the higher the loan portfolio and the
higher the profits.

The issue of dividends
• The basic conflict in banks is that shareholders want profits and all other
stakeholders, in particular depositors, want solidity and reliability
• A major factor in bank solidarity is the capital base which will be reduced
by the payment of dividends. This reduces the ability of the bank to
increase its loan portfolio and thus its profitability
• If no dividends are paid the capital is increased and the value of the shares
will increase.
• Companies can take this increased value when revaluing their portfolio,
individuals usually can’t and want cash

Module 4
Measuring and maintaining
the quality of the assets

Controlling the loan portfolio
• Most bank failures result because the bank runs out of cash to pay its depositors
or its loans default and turn bad.
• Loans are the largest part of the assets of the bank, often 60% but sometimes
more (70% is high and 80% is too high).
• The directors cannot and should not become involved in individual loan
decisions. They don’t have the expertise and it provides an umbrella to the
management “The Board of Directors approved this so it must be good and it is
not our responsibility”.
• Directors control the loan portfolio through:
– Agreeing the strategy of the bank (see Module 8)
– Establishing a Risk Appetite of the Board (see draft document)
– Written loan policies
– Ensuring the bank has a fully operational internal control system (see Modules
10 and 11)

Written loan policies
• Most banks now operate with written loan policies which are
recommended by the management and approved by the
Board of Directors.
• These loan policies will be detailed and cover all the major
issues. GBRW are happy to provide a list.

Discussion topic
The only question a lending banker has to ask is
“How do we get repaid?”
Banking facilities should be self liquidating.

The Risk Appetite of the Board
• A short, 2 or 3 pages, high level statement made every year to the
management of the bank giving a broad directive on how the business
should be developed and the limitations on that development.
• An example can be provided by GBRW
• This is written by the Board of Directors and presented to management
(who can comment because they have to implement it but they cannot
change it if the Board of Directors are happy with it)

Loan Risk Rating System
• Almost all banks now give a rating to each individual loan.
• All loans generate a general provision of 2% of the loan amount
• These ratings are usually:
A: Satisfactory loan: is functioning normally according to the contact with the customer (2%
general provision)
B: Potential problem loan: there are some things wrong which if not corrected could result
in a loss (5% - 15% specific provision)
C. Substandard loan: there are obvious problems, in particular if interest and principal
payments are late (16% – 40% specific provision).
D. Doubtful: full repayment is now unlikely (40% - 75% specific provision)
E. Loss: uncollectable and taken off the portfolio (100% full provision)
• The allocation to categories C, D and E should be based on the number of days payments are past
the due date. The percentage within each category is based on management assessment of
collectability. Loans in category A and B should not be past due by more than 45 days (sometimes
60 or even 90 days) which is enough time for the Business Development Officer to correct the
default.

Issues for the Board of Directors
• Is the Risk Rating System fair and reasonable? It should be reviewed once
a year by the Board.
• Are the loans given the right risk rating by the Front Office/Credit
Committee?
• Is that risk rating agreed by the independent Risk Management Division
(which can create tension)
• Is the risk rating reviewed at least once a year on every loan – including all
long term loans?
• Are loans being artificially kept in Categories A or B through maturity
extensions or bullet maturities? How many times can a loan be extended?

What can the Board of Directors do if
loan losses are too high?
• What is too high? Every problem loan is one problem too many. There is nothing more expensive
than a problem loan. The bank is in the business of risk so problem loans are inevitable.
• If the average margin is 4% and losses on the portfolio 2% is that too high or acceptable business?
• Require greater authority and resources be given to Risk Management Department and in
particular the Loan Recovery Department but this will be expensive and is a negative rather than a
positive reaction. Cut operating costs?
• Change the management but what if they are within guidelines and done everything that the Board
has instructed them to do?
• Change the strategy and Risk Appetite of the Board. The ultimate responsibility
for losses lies with the Board of Directors and not the executive.
“The fault dear Brutus lies not in the stars but in ourselves”
William Shakespeare.

Module 5
Providing competent and
honest management

Responsibilities of the Board
• The Board delegates responsibility and authority for the daily running of the bank
to the management and thus they are the only people who have any executive
authority (the Board has no executive authority).
• However, the Board are still personally accountable to the shareholders and other
stakeholders for the safe, sound and efficient operation of the bank (and this
members of the Board require Directors and Officers Insurance)
• The Board are primarily responsible for the nomination of the Chief Executive
Officer and the ratification of his/her appointments to the Board of
Management.
• All appointments below this level are the responsibility of the Board of
Management (apart from the Internal Auditor and the Company Secretary who are
appointed by the Board of Directors)

Nomination Committee
• A committee of the Board of Directors who considers all matters relating
to the employment and dismissal of the management before making a
recommendation to the Board.
• Sometimes it can be the “Nomination and Remuneration Committee” of
the Board. The Remuneration Committee review and recommend to the
Board of Directors the salary and bonus/inventive scheme of the CEO and
senior management.
• GBRW are happy to provide a draft charter of the Nomination and
Remuneration Committee

The Chief Executive Officer
• This is the key appointment. The CEO is usually a member of the Board of Directors
so his/her appointment has to be approved by the shareholders.
• There has to be complete trust between the CEO and the Board. The Board has to
be wholly confident that the CEO, and hence the executive management are
acting in accordance with the guidance of the Board. The executive implement the
policy of the Board.
• A primary responsibility of the CEO is to build a team as her/she cannot be
expected to take every executive decision (if they think they can then they are a
danger to all stakeholders – and themselves).
• The CEO, along with the Chairman of the Board of Directors, is the public face of
the bank.

Discussion topic
How should the Board of Directors deal with an
over confident and domineering Chief
Executive Officer?

Salary and bonus schemes
• A key control of the Board as it encourages the executive to do what you want
them to do.
• Annual bonus is paid to members of the Board of Management on achievement of
Key Performance Objectives (KPIs).
• These KPIs should not only relate to profitability but also to building the strength
and security of the bank e.g. reduction in problem loans, building the retail deposit
base, reduction in growth of costs – in other words an incentive for management
to meet the objectives of the Board.
• The maximum annual bonus should not generally be greater than 130% of salary
or the total bonus for all executives be greater than 2.5% of the equity of the bank

Team building and trust
• The Board of Directors and the Board of Management have to work
as teams.
• The doctrine of collective responsibility applies to both boards. You
cannot duck out of a decision by voting “no”.
• The Board of Directors have to entirely confident that the executive
are doing what they are asked to do and the executive have to be
entirely comfortable that the Board will not give them
unreasonable and unrealistic targets and objectives.
• It comes down to trust, working together and actually liking each
other or at least having respect for each other. There is no room for
mavericks when handling other people’s money.

Fostering a culture of professionalism,
fair dealing and integrity
• A bank lives by its reputation, without this the house of cards
will collapse. It has to be seen by the world at large as honest,
fair and competent. An institution to be emulated.
• The job of the Board of Directors is to foster this culture,
mainly by not insisting on unrealistic profit targets that might
push management to unethical practices but also by example
and regulation.
• GBRW are happy to provide a draft Code of Ethics.

Module 6
Understand the earnings of
the bank

What can shareholders reasonably
expect?
• The shareholders are taking a risk in investing in the bank and thus
deserve a premium over and above what they would have earned if
they had invested in a risk free asset such as Treasury Bills – a
premium of 3% would be reasonable.
• To push for a higher return may be achieved in the short term but
may well result in problems at a later date – it is always easy to lend
money, getting it back can be the hard part.
• Thus a key to successful banking is to limit the influence that
shareholders have upon the bank – which is one of the objects of
Corporate Governance (see Module 2).

Where are the earnings coming from?
• Directors need to understand the business model of the bank.
• A sudden increase in earnings needs to be understood,
especially if it comes out of the Treasury and Trading Division.
Increased earnings usually means increased risk
• Monitor the ROAA (Return on Average Assets) and the
reasons for any change for it may be good or bad news.

The knotty question of pricing
• Any fool can make a cheap loan or bring in an expensive deposit. The
Front Office divisions have to work within parameters (this usually creates
difficulties and special pleading for “deserving” credit applications).
• Minimum and maximum pricing policies on deposits as well as loans are
set by the ALCO as they have the overview with responsibility for the bank
meeting its Return on Equity and other targets.
• Does the bank calculate the true cost of making a loan?
• The bank needs to factor in amongst other things the cost of involuntary
deposits, usually at a cheap rate, with the central bank, potential loss
losses, share of operational costs as well as funding and use of capital
(every asset has a capital cost)

Cutting the cost of providing a loan is as
valuable as increasing the margin
… and less risky. The higher the margin a customer is prepared to pay the greater
their need for cash and the risk to the bank.
Cheaper funding is the fast track to greater profitability.
Operational costs will always rise and sometimes are on the fast track as well. The
key is to limit the increase to around the rate of inflation

Discussion question
How can a commercial bank limit the increase
in its operational costs?
through centralisation, standardisation and mechanisation?

MODULE 7
Conservative liquidity and
funding allow the bank to
survive

Having enough cash at the right time
is the key
• Banks go bankrupt when they don’t have enough money to meet their
liabilities. This arises from:
Funding Liquidity Risk (not enough cash)
Market Liquidity Risk (markets drying up suddenly)
• If banks held all their assets in cash they wouldn’t make any money.
• Thus there has to be a balance between available cash and assets that
take time to turn into cash such as loans and fixed assets.
• The usual benchmark is that liquid assets (those that can be turned into
cash within 30 days) should be around 30% of total assets.

Maturity miss-match position
• The most important document produced by the Secretariat to the ALCO is the
maturity miss-match position.
• This shows the maturity dates of the assets and liabilities of the bank in series of
“buckets” or time zones.
• The hard part is getting it right (the liabilities can be legally due and payable before
the bank thinks they mature) and deciding on the maximum open short positions
in the short term “buckets.
• This means how large a gap is it safe and prudent for the bank to allow (or has to
fill if there is a crisis)
• The Board of Directors should ask management how they propose to fill those
gaps should the need arise (use standby credits, lay off part of the loan portfolio at
a discount, convert deposits to equity).

What is liquidity?
• Liquidity is defined as:
– cash held by the bank,
– short term deposits with reliable financial institutions (including mandatory deposits with the
central bank)
– investments in undoubted instruments that can be converted quickly into cash, this usually
means Treasury Bills that can be sold on a secondary market (albeit at a discount but cash
when you need it is more important than price).
• The trouble with liquid instruments is that they don’t earn as much money as
loans.
• Cash is an expense to the bank (it has to be counted, moved and insured and earns
nothing). Short term deposits with banks earn very little return and liquid
negotiable instruments pay a very low rate if they are available at all.
• The ALCO needs to establish a Minimum Liquidity Guideline

What happens in a crisis?
• Depositors demand their money back. Banks are usually the first as they know what is
happening, then corporate depositors and finally retail depositors.
• Retail depositors will be more loyal or misinformed (and maybe they think they are
covered by the national bank deposit scheme which may not always be the case if they
don’t have enough money themselves)
• Term depositors will also demand their money back (the law may be on their side)
• Repayment of customer loans will slow. They will think they won’t have to repay if the
bank goes bankrupt and may need to be reminded of their legal obligations.
• All sources of new funding will dry up
• Everything will come down to daily cash flow (and confidence in survival)

Central role of the ALCO
• The ALCO (the Assets and Liabilities Committee of the Board of Management)
is the most important committee in the bank – more important than the
Credit Committee.
• The ALCO is the pumping heart of the bank that circulates the blood in the
form of cash around the bank.
• GBRW can provide a charter including the role and responsibilities of the
ALCO.
• A fully functioning ALCO is central to the security and safety of the bank.
• The Board of Directors should have available copies of the presentations made
by the ALCO Secretariat as it should contain all the information needed for the
Board to be satisfied that the bank is adequately and prudently funded.

What ratios should the Board look at?
• Capital Adequacy Ratio (ideally 2% over the ratio required by the regulator)
• Liquidity ratio: how much cash is readily available to the bank? 30% of total assets available within 30 days is an
international standard.
• Deposit to loan ratio: how much of the deposits are used to fund the illiquid loan portfolio – 80% would be a
benchmark. More should generally be avoided.
• Number of large loans: maximum loan 25% of total equity. Loans over 10% of equity to be restricted to 10
facilities
• Number of large deposits: banks should avoid large deposits in the same way that they should avoid large loans.
The sudden withdrawal of a large deposit or deposits could lead to a sudden lack of liquidity.
– Deposits in excess of 25% of the capital should not be sought and the number of large deposits in excess of 10% of capital should
be limited e.g. the 10 largest deposits should not be in excess of 300% of capital
– Typically large deposits from the state or state owned enterprises can lead to a concentration of deposits that are vulnerable to
political change.
• Operating costs as a percentage of total income. Some banks claim 40%, a more normal figure is 60% and 80%
is too much and “something needs to be done”..

STRUCTURE OF THE BALANCE SHEET
Capital and Liabilities Assets
Capital Cash and banks 10
Tier 1 10 Liquid investments 20
Tier 2 (Sub' debt) 5 15 Total liquidity 30
Bonds and MT loans 10 Loan portfolio 65
Deposits 75 Fixed assets 5
Totals 100 100

What are the danger signals of a
pending liquidity crisis?
• An increase in the cost of funding the bank that is not related to a general
increase in interest rates.
• A change in the composition of deposits, the bank bidding for additional
funds in the money markets.
• Liquidity ratios under pressure (as in the example above)
• Adverse press comment (directors should always keep their eye on the
press)
• Other banks cutting their inter-bank lending limits (banks are always the
first people to sniff out a crisis)

Discussion topic
What do you do if there is a liquidity crisis in the
bank (or in the banking system generally)

MODULE 8
Strategy is a key control
instrument of the Board
59

The strategy of the bank is approved
by the Board of Directors
• The Board should give an annual instruction to the management to
prepare an up-date of the 5 year Strategic Plan and add some brief
guidelines (maximum 1 page).
• The Strategic Plan is prepared by management because it is they who have
to implement it. They have to believe in it (and their bonus depends upon
it).
• The Strategic Plan must include projected 5 year Balance Sheet and Profit
and Loss Account (the first year of which forms the 1 year Business Plan).
• This is a principal tool by which the Board provides guidance and direction
to the executive
60

What are the basic strategies needed
by banks to survive?
1. Make sure the bank never runs out of money (the job of the ALCO
monitored by the Board of Directors)
2. Make sure the bank is not swamped by bad debt (the job of the Credit
Committee guided by the Board)
3. Keep operational costs under control (the job of the CEO monitored by
the Board)
4. Ensure that the operations and business of the bank are tightly
controlled (the responsibility of the Board)
5. Make sure that the bank always maintains its reputation for prudence,
safely and soundness as a place for customers to deposits their hard
earned money
61

Discussion
What strategy should the bank follow in an over saturated banking market?
1. Retail or corporate or both?
2. Large corporate or SME or both?
3. Nationwide or regional?
4. Expand or cut back on branch network? It is expensive. Internet and telephone banking are cheaper
5. Can you afford the IT necessary to keep up with foreign owned banks?
6. Can you afford a quality customer service or do you go for volume. The MacDonald's approach.
7. How broad a range of bank products and services? Specialised or universal?
8. Buy in deposits or build retail?
9. Subsidiaries to market specific products such as leasing, factoring, home loans
10. Target Return on Equity to satisfy shareholders whilst remaining a safe and sound bank.
Most banks have roughly the same Strategic Plan, so what do you do to
make your bank special?
62

Module 9
Compliance with the
regulatory and legal
framework

110% compliance
• The bank has at all times to be wholly compliant with all regulation and
domestic and international law as well the covenants of any Loan
Agreements entered into by the bank
• To avoid mistakes or a sudden event taking the bank down to 95%
compliance it is sensible to ensure 110% compliance e.g. on minimum
Capital Adequacy Ratios, Liquidity Ratios, Large Loan policies etc.
• The Company Secretary has a primary responsibility to ensure that at all
times the bank is operating within the law (the Company Secretary reports
to the Board of Directors not the executive of the bank)
• The ALCO report will provide confirmation of compliance with the
requirements of the local regulatory authority.

AML, CTF and FATF
• The directors are required to embed a culture of compliance with all domestic and international
law to preserve the reputation and integrity of the bank, something that has been recently sadly
lacking in some major banks such as Barclays and HSBC to their considerable cost.
• The language of initials: AML (Anti Money Laundering), CTF (Combating Terrorist Financing), FATF
(Finance Action Task Force and their 40 recommendations).
• Beware the global reach of US legislation: OFAC (The Office of Foreign Assets), US Patriot Act and
FATCA (Foreign Account Tax Compliance Act).
• To protect themselves the directors need to ensure that there is a full methodology in place to deal
with all these issues: including fraud prevention, anti-bribery and corruption, identity theft and
“phishing”. Training needs to be provided to all staff, including members of the Board of Directors
(e-learning will considerably reduce the cost).
• This can bite you as many decisions are taken lower down the decision making chain.
GBRW Consulting. London 65

A word about international loan
agreements
• It is always attractive to obtain longer term funding from international institutions. The long
term money can be used to fund the longer term needs of customers and the fact that the
bank can borrow from an international institution enhances the reputation and standing of
the bank.
• However, there may be drawbacks:
– The loan may be made in a foreign currency and the exchange risk will fall upon the bank
and not the lender or be passed to their customers which is effectively the same thing.
– The loan will come with conditions. These conditions will be much the same as
international standards but may not always suit the business model of the bank.
– The lender may not be sympathetic should any of these conditions be broken
– The loan could be expensive in relative to the cost of short term local deposits.
• The bank should approach such agreements with some caution as it will probably entail some
of loss of independence/compliance with international standards. This may be no bad thing
but you should understand the implications.

Is it worth obtaining an international
credit rating?
• An international credit rating from Standard & Poors, Moodies or
Fitch will concentrate the mind of the executive to comply with
international standards (and thus domestic regulation).
• A reasonable credit rating will encourage international investors to
deposit funds or invest in Tier 2 capital of the bank.
• The bank cannot have a better credit rating than the country in
which it operates. If the country has a poor credit rating it is
probably not worth the expense of obtaining a credit rating.
• However, it is probably worth the cost and disruption, if only
because it gives an insight into how international lenders expect
banks to be run and pushes the bank in that direction if it is not
there already

MODULE 10
Audit and Reporting

Central role of the Audit Committee
• The Audit Committee protects the Board of Directors from heavy
fines or even jail.
• The Board of Directors cannot themselves verify the accuracy of the
accounts nor compliance with all law and regulation.
• They rely on the Audit Committee who themselves rely on Internal
Audit Department and the external auditors of the bank.
• The auditors confirm to the Audit Committee that the accounts
are accurate. The Audit Committee confirm this to the Board of
Directors and the Board of Directors confirm this to the
shareholders.
• If it turns out that this is not the case, then it is the Board of
Directors who are responsible for not putting in place the right level
of controls.
• GBRW can provide a draft charter of the Audit Committee.

When did Internal Audit tell you
something you didn’t know already?
• The central problem is that the Internal Audit Department may report to the
Audit Committee but operationally they are controlled by the executive of the
bank.
• They are not likely to seriously challenge the people that set their salaries,
bonus scheme, promotion and transfers.
• Thus they can be only box tickers, checking the minutia of the bank’s
operations but missing the big issues. This is of course not true in every bank
but you are fortunate if they provide you with useful insights and are able to
address the “hot potatoes” such as lending to bank officers or companies
owned by them, large loans to influential borrowers, conflicts of interest.
• The minutia has of course to be checked but don’t rely on Internal Audit to
protect the Board of Directors from challenge from the shareholders.

Discussion issue
How can the Board of Directors make the
Internal Audit Department more useful and at
the same time provide protection for them?

How to get more out of the external
auditors
• The bank has to have an external audit from a major international firm,
otherwise it will not be credible.
• That audit has to be clean and prompt (not 6 months after the reporting
date when it is published)
• The fees of international firms are time based so negotiate for the bank,
usually the Internal Audit Division, to do as much of the audit preliminary
work as they can before the actual external audit starts.
• Pay great attention to the “audit letter” following completion of the audit
• Bring them into the Audit Committee as they have broad experience of
dealing with issues in many banks.

Monthly Report
• The key reporting documents are the Monthly Report by the executive of
the bank and the ALCO report (see Module 7)
• The Monthly Report should contain the information set out in the
attachment and be available within 10 days of the end of each month.
GBRW Can provide examples.
• The meetings of the Board of Directors should be scheduled so that the
Monthly Report for the previous month is available to them

Basle II
Now a standard banking requirement of all supervisors worldwide. It has 3
pillars:
1. Minimum capitalisation to cover the 3 main risks faced by banks:
credit, market and operational risk.
2. The regulatory response to the first risk
3. Market discipline and disclosure requirements
What it means is that all banks have:
– To have an independent Risk Management Division (RMD) that
identifies, measures and then controls credit, market and
operational risk.
– Sufficient capital to cover each of these risks (this means more
capital than you have already)

Chief Risk Officer (CRO)
• Head of the Risk Management Division.
• GBRW can provide Job Descriptions for all key roles in a bank.
• Possibly the most difficult job in the bank as it requires considerable
knowledge, tact and courage. Their job is to put first the needs of all
the stakeholders of the bank and the customer second.
The role of the Board of Directors is to ensure that the
bank has an independent and strong CRO who can
balance the security of the bank with the need to
make profits

Credit Risk
• The RMD has to approve all corporate, retail and treasury
lending limits from the point of view of the security and safety
of the bank.
• It is easy and safe to say “no” to lending proposals but then
the bank will not make any money.
• This can be a source of conflict with the Front Office Division.
• The CRO must have the full support and confidence of the
CEO and the Board of Management.

Side issue: how to decline credit
• When the RMD or the Credit Committee decline a lending proposal, they should
give 3 reasons. One of those may be gut feel “I just don’t like the proposal” but
two should be banking reasons.
• This is so that the Business Development Officer can go back to the customer with
reasons for saying “no” and not just say “no”. A good number of proposals, maybe
30%, will come back in an acceptable format and you have gained a good customer
and a happy Business Development Officer
• In the same way the RMD or the Credit Committee should not give conditions to
approving credit. Credit approval is not a negotiation, that is the role of the
Business Development Officer. You should either say “yes” or “no” and give 3
reasons.
• It is a lot easier if the bank provides Business Development Guidelines. Proposals
can be compared with the guidelines and “3 strikes and you are out”,

Examples of market risk
additional to those in attached job description of CRO
• Interest Rate Risk: bank makes fixed rate loans funded by floating
rate deposits. How much does the bank loose if interest rates rise
by 2%?
• Exchange Rate Risk: bank makes loans in Euro funded by US$
deposits. Who fills the funding gap if the value of the US$ falls by
10% against the Euro? The cost of the additional funding can’t be
passed onto the customer.
• Value at Risk: how much might the bank loose if the value of its
investments fall?
A failure in market risk is the greatest danger faced by the Bank.
Without adequate funding and liquidity the bank will not survive.

Operational Risk
• This is the risk of losses to the bank arising from inadequate or failed
internal processes, people, systems or external events.
• The Job Description of the CRO provides a fuller list of the risks to the
bank of operating a banking business.
• These risks are considerable and usually under-estimated especially:
The risk of the IT system of the bank being attacked
The reputation and honesty of the bank being questioned
• System of “Traffic lights” to monitor operational risk throughout the
organisation.
• The level of additional capital required to cover these risks may be around
15% of net revenues which is expensive.

Question?
What can the Board of Directors do to protect
the independence of the CRO and enable
him/her to make decisions without worrying
about their future career in the bank?

MODULE 12
What can go wrong and what the
Board of Directors can do about it

Reliance on volatile and unreliable
funding sources
• A major if not the primary reason for bank failures. One of the
problems about banking is that you know the maturity date and
amount of your liabilities down to the last cent, you can never be
sure of the value of your assets, apart from cash which is an
expense.
• Not paying your liabilities in full and on time is the short route to
bankruptcy.
• The Board of Directors are heavily reliant on the ALCO to have firm
grip on the funding and liquidity of the bank.
• They also need to understand these issues when reviewing and
approving the Strategic Plan.
• It will also form part of the annual Risk Appetite of the Board.
The major dangers are reliance on being a “bought money bank”
followed by “borrowing short and lending long”.

Imprudent loan practices and sector
exposure
• The classic route to bank failure as a result of poor lending is
exposure to property development, in particular speculative
property development. Don’t get heavily involved however
attractive the proposal may appear.
• The Board of Directors can approve the wrong strategy,
assuming they were fully aware of what was going on.
Whatever way the directors are to blame.

A weak Board of Directors not
understanding the business
• It can be very difficult if the board comprises of amateurs who are not
familiar with the business, and only involved for a few days a month, to
have a real understanding of the risks being taken by the bank.
• Boards need to understand where the profits are coming from, this
includes profits from the Treasury and Trading Division
• The main protection should be the Chief Risk Officer

Be aware of what is happening in the
Treasury and Trading Division
• The Treasury and Trading Division should be making a substantial contribution to
the profitability of the bank, essentially by managing the overall cost of funding
the bank and executing foreign exchange transactions for customers.
• Traders will need to run short open positions in maturities, currencies, securities
and commodities. “Open positions” means “speculation” and banks have lost vast
sums as a result of trading losses. Short positions (a few hours) should not become
long positions without Risk Management Division approval.
• Providing there is a tight control regime, there is a place for limited speculation
with the bank’s own money (not client’s money) but beware exceptional profits
and trading that cannot be easily explained.
• There is a tendency for the Treasury and Trading Division to “blind the rest of the
bank with science” so that nobody is really sure what they are doing. The Board of
Directors need to make sure that the CEO and the Board of Management are on
top of this.

What Boards need to do to protect
themselves
1. Know and understand their business by being well informed, experienced
and able to withstand pressure.
2. Build a culture of prudence and professionalism throughout the bank
3. Foster an absence of greed: profits “yes”, excessive profits “no”. Don’t
push management too hard for profits.
4. Push the bank to be sustainable rather than short term, in other words
relationships and solidarity are more important than transactions.
5. Ensure a working corporate governance procedure
6. Support an independent and strong Chief Risk Officer
7. Establish an active and real Audit Committee
8. Build an independent Internal Audit Department

Module 13
The future of banking?

Competition will always be heavy
• Just accept that you will always face heavy competition from other
banks, in particular foreign owned banks who will have access to
much greater resources than you have, in particular cheaper
funding and IT.
• The idea is to make your bank:
more efficient (cheaper to run),
more attractive (customers want to come to you)
so secure that nobody ever worries about your future.
• This probably means concentrating on standardisation,
centralisation and mechanisation.

Beware the temptation to
concentrate on major companies
• All banks naturally want to bank the major companies, they tend to be
more credit worthy, the sums involved are much larger and they bring
with them some prestige.
• However, they are not as reliable as customers and will move to a more
competitive bank without much sense of loyalty.
• This competitive bank will often be a foreign bank with much greater
resources and range of services.
• In developed economies, the banks have relatively little lending to major
companies as they have been refinanced through the bond market.
• Banks should have broad spread of business, maybe think for the
Strategic Plan in terms of 4 or 5 major business sectors so that if one goes
it will not be a disaster.

What most domestic banks do
• As they grow and develop, most banks have to gravitate towards
retail and smaller corporate business (SME) whilst holding onto as
much large corporate/state owned company business as they can.
• All banks should provide foreign exchange and trade finance
products for customers but they should also think about small ticket
leasing, factoring, franchise financing, securities broking, corporate
finance, asset management, insurance – quite often through
subsidiaries or joint ventures.
• Most banks aim to be represented in all cities and most towns in
their countries or regions of operation. The problem is that
branches are expensive.

Cost control
• Running a bank is expensive. Operating costs are high because a bank employs a
lot of people (and numbers are increasing to satisfy the requirements of the
regulators and the need to bring in new products and services).
• Keeping a limit on the growth of costs is key.
• This can only be achieved by:
a) Standardisation of products (tailored facilities are expensive)
b) Centralisation of everything that can be centralised in Head Office or Regional
Offices (Back Office, Risk Management, Human Resources, IT, etc).
c) Branches are marketing units not mini banks.
d) Get the customers to do the work: internet banking, telephone banking, filling
out their own applications for house loans, consumer credit etc.
d) Maximum use of score cards and IT
• The biggest expense after staff will be IT (and many banks have either failed to
keep up or had to merge with other more advanced banks).

Cut out “dead money”
• Look at the assets side of the balance sheet and consider how much
is earning a return.
• Cash is a problem. It has to be counted, insured, transported and
held in a secure area. It earns no interest. It is an expense and the
holding should be minimised as far as possible.
• Fixed assets are also a problem. They earn nothing and, apart from
cars, offer no source of swift liquidity in case of need. The funding
could be better employed. Consider sale and lease back to free up
the cash.
• The bank has to have liquidity, which will earn less than loans. It is
the job of the Treasury and Trading Division to find secure, liquid
markets to place the liquidity of the bank.

Banking should be safe
• Banking is a utility industry. It provides an essential service to the community.
• To be consistently profitable it has to be a volume business, delivering standard products
efficiently and cheaply.
• Avoid the exotic and “once in a lifetime” proposals. They are too good to be true.
• Everybody in the bank should aim to have a good nights sleep without worry and concern,
especially the members of the Board of Directors and the CEO (and the CRO).

GBRW Limited
GBRW is a banking consultancy based in London. It is staffed entirely
by former senior bankers.
GBRW would welcome the opportunity to better understand your
interests and needs relating to the issues raised in this document.
Please contact us through jeremy.denton-clark@gbrw.com or calling
our London Head Office on 00 44 (0) 20 7382 99000.
To find out more about GBRW please go to www.gbrw.com.

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