Every FDIC-insured bank is subject to a periodic examination that is of significant importance to the bank and its business activities. If the examination goes well, the bank generally will be free to pursue those business activities it determines to be appropriate. If the results of the examination are less than satisfactory, the bank will essentially be handcuffed from pursuing strategic activities. Instead, the bank will be allowed to pursue only those activities the regulators deem appropriate, which generally include non-strategic activities that are intended to improve the bank’s safety and soundness or compliance function. The importance of the examination and its results should not be lost on any community bank director.
Given the importance of the examination process, the bank’s outside directors should be well-prepared for this critical two to three week time period. Unfortunately, many outside directors are not. A good number of outside directors fail to appropriately prepare themselves for the examination process. This failure could lead to significant, negative adverse consequences to the bank. The following describes the three most critical areas where outside directors should prepare themselves prior to the beginning of the annual examination.
- Understand Current Asset Quality
It is imperative that outside directors have a solid understanding of the bank’s asset quality, particularly in the loan portfolio, prior to the examination. The outside director should discuss the bank’s asset quality with the management team prior to the examination, paying particular attention to the bank’s problem loans and the associated work-out plan. Ensuring the outside directors understand both the extent of the problem assets and the proposed course of corrective action proves to the examination team that the directorate is engaged in appropriate oversight of the bank’s asset quality. The director’s failure to truly understand the bank’s current asset quality is evidence of poor board oversight, and will likely result in the examination team having little to no confidence in the directorate.
- Understand the Bank’s Enterprise Risk Management Program
The bank’s outside directors must be able to fully articulate the bank’s enterprise risk management program. Each director’s responsibilities in this area are two-fold. First, the directors must understand the multitude of risks facing the bank. Second, the directors must be able to articulate the various aspects of the bank’s enterprise risk management program that are being implemented to appropriately control these risks. If the examination team does not believe the directors have an understanding of the bank’s risks and risk control measures, the examination team will find that the bank does not have adequate enterprise risk management.
- The Directorate Must Be a “Credible Challenge” to Bank Management
Many community bank boards can be classified as “rubber stamps” for bank management. These boards are evidenced by a long string of unanimous votes in favor of whatever bank management recommends. If this type of voting history is present, the examination team may very well determine the outside directors do not act independently of bank management, but are there instead simply to collect paychecks and rubber stamp what bank management is doing. The outside directors must be able to prove to the examination team that they are willing to vote against bank management when the outside directors determine it appropriate to do so.
Some outside directors believe that preparation for the examination process is unnecessary because they do not have direct interaction with the examination team. Although the examiners may not interview each outside director during the examination, this sentiment is flawed. The examination team reviews all of the important documentation related to the bank’s corporate governance. The examination team will know if the outside directors do not have a full understanding of the bank’s asset quality or enterprise risk management program, or are unwilling to act as a credible challenge to bank management. It is important for the bank’s outside directors to appropriately prepare for the examination to avoid these examination findings, which will ensure the bank’s ability to pursue strategic activities aimed at improving the organization’s overall value.