In banks, the mavericks survived

This is in part because the banks that avoided the worst of the problems appear to be those who do not follow every last line of the corporate governance handbooks. A study published this week by Nestor Advisers compares and contrasts the governance and performance of the 25 leading European banks by market capitalisation — a moveable feast admittedly — and it found that ticking the right boxes was no defence against disaster. Indeed, rigid adherence to all aspects of the Code might do banks some harm, as explained in the following extract.

"We found no relationship between the relatively high proportion of independent directors and performance. Among the better-than-average performing banks, three had not split the roles of the chair and chief executive until late 2007 and others had retained the former chief executive as chair. This seems to fly in the face of perceived corporate governance wisdom that the chair should be independent."

Not content with that, it suggests that banks should ignore or get exempted from part of the code.

"We believe that in highly complex and risk-sensitive organisations such as banks, there might be special value in continuity and, particularly in the case of a former chief executive becoming chair, a more enhanced balance of power may result from the presence of a knowledgeable chair at the helm of the board."

It came to this conclusion because it found that boards led by finance industry experts did a better job than boards led by non-financial experts.

But might that not be the case across the whole of commerce and industry if a similar study was done? Most people would assume that a chairman who knows about an industry will do a better job and be more adept at asking the right questions than a complete stranger to it. Only the drafters of the governance code seem to think the job can safely go to anyone provided he or she is independent — taking the view that industry knowledge, while it might be desirable, is not essential.

The requirement that non-executive directors leave a board after nine years for fear of no longer being independent is also challenged. Nestor Advisers says that in future such levels of professionalism, time and expertise will be needed from a bank's non-executive directors that if an organisation finds a candidate who ticks all the boxes it should hold on to him or her and not worry about "independence".

The other important observation of the report is how non-executives did not stand back and look at the business but instead saw it through the same lens as that used by the management, and therefore failed to spot the traps. Given their only real job is to make sure the bank is able to open for business next week, their key skill should be to ignore the cloying operational and compliance detail and focus on the big picture. Nor should they judge performance by superficial measures like return on equity — selected because in the short term it allows management to improve performance and hit bonus targets by improving leverage. How woefully short of this they fell.

And yet as an aside, and while falling so woefully short, no doubt these boards complied with another aspect of corporate governance — the need to assess their own performance and report on the strengths and weaknesses of the boards own operations. No doubt they gave themselves a clean bill of health, or kept quiet about any shortcomings. Here too they will need to try harder.

How far short of this ideal non-execs fell is illustrated by these three major failures in risk control. They made no attempt to curb leverage. They underestimated the liquidity risk in the business. They were seduced by the spurious accuracy of risk management models. They should have made their own minds up about what might or might not be a source of risk. All this suggests that the culture is where the problem lies and this too was confirmed by the way risk managers were treated in different banks. There was no correlation between a bank's ability to survive and whether or not it has a risk officer and risk committee. There was a correlation between the survival of banks and the boards where the risk officer was treated as something rather better than what the cat had just brought in.

The great benefit of this Nestor Advisers report is it details what actually happened in the banks whereas so many of the solutions now being proposed for our brave new world have neither been researched nor have any supporting evidence to suggest they will address real causes. Unfortunately it catalogues the governance shortcomings so well, that one wonders if they can ever be solved. Might it not be easier to make the banks smaller and simpler, rather than look for a legion of super-heroes to run them?