Bank board governance failures are never that simple
Updated: Oct 25, 2019
This article first appeared in the opinion section of the Australian Financial Review on the 13th February 2019. Click here to view the original version.
There are several ironies associated with the resignations of Ken Henry and Andrew Thorburn last week. Fifteen years ago, almost to the day, the then chairman and CEO of the NAB – Charles Allen and Frank Cicutto – announced their resignations, albeit two weeks apart.
In addition, all the resignations were brought about by similar circumstances: failures in governance. Allen and Cicutto resigned after the infamous FX trading scandal, which was preceded by the large write-off to the Homeside mortgage business. Henry and Thorburn were brought undone by the numerous revelations during the Royal Commission, predominantly the fee for no service issue.
What's more, although the resignations are 15 years apart, they are not necessarily disconnected in time. According to a report published by ASIC in October 2017, the practice of collecting fees for no service at the NAB commenced in April 2004, a little over three months after the NAB announced the FX trading losses to the market.
And finally, for me, there is a personal irony in the resignations. In 2004 I was publicly named as one of the "whistleblowers" in the FX trading scandal. In 2016, just before leaving the NAB, I launched a book titled "The Origins of Ethical Failures" which was partly a reflection on this experience. Ken Henry wrote the foreword to this book.
Suffice to say, last week caused me to pause and reflect. I obviously know Ken and have had the privilege of sitting down with him one-on-one on several occasions over the past two-three years. I also know Andrew and although we have only spoken on a handful of occasions, there is no question that both he and Ken were deeply committed to restoring integrity in banking.
Although I didn't know and never met Allen and Cicutto, I would think that those who did would also have a lot of positive things to say about them. They too, I imagine, would describe them as leaders who were committed to doing what is right, placing a premium on ethical conduct.
So how do we explain their inability to do so?
Of course, there are no straightforward answers to this question. And as they say, comparisons are odious – despite some of the links, it would be misguided to draw parallels between these stories. But it does demonstrate the challenges facing any director or executive who wants to drive a turnaround in an industry as fraught as banking.
The often-heard refrain is that boards are ultimately responsible for the governance of an institution. In theory, this makes a lot of sense. For the system to work, accountability needs to reside somewhere. And as uncomfortable as the resignations of last week have been for the individuals involved, they are a sign that the system is "working".
However, in practice, the role a board plays in abetting a failure in governance is not as obvious as it might seem. It is rarely the case that directors or executives are knowingly engaging in, condoning, or turning a blind eye to wrongdoing. Rather, in most circumstances, the role they play is far more subtle and indirect.
The APRA investigation that followed the FX trading scandal suggested that the NAB board was not fully aware of the risk issues within the FX business. When they were presented with information suggesting that there was a problem, it failed to properly express the gravity of the issues. Perhaps the board unwittingly played a role in creating a culture that did not encourage the surfacing of bad news?
The evidence presented at the Royal Commission showed that the NAB board had been aware of the fee for no service issue for some time. Yet despite their best efforts, they were unable to have management expediently address the issue. Perhaps the board relied too heavily on the assurances provided by management?
The point is that although in theory we do need to make boards accountable for governance, in practice it is impossible for them to be responsible for, and have knowledge of, everything that happens in a large institution. Arguably the best they can do is put in place the formal and informal mechanisms that are supportive of good governance.
But at times even this is hard to do. Much of what Hayne presented in his final report was not a surprise to those of us who have worked in the financial services industry. For example, we have known that the conflicts of interest that litter the system – the most obvious being the incentive schemes – play a role in abetting wrongdoing. So why don't boards just scrap bonuses?
Unfortunately this is far easier said than done. The concerns raised by some witnesses at the Royal Commission about the disadvantages associated with being a first mover are legitimate. In addition, those who claim that it is a simple matter of directors passing a directive to remove all variable remuneration have obviously never sat between a banker and a bonus. Refer to the upcoming pushback from the mortgage broking industry.
The fact is changing large, complex systems is difficult, especially when many of the features of the system that need to be fixed are so heavily ingrained and intractable. Therefore, we should not expect the next CEO or chairman of NAB to be saviours. They will face similar challenges to their predecessors.
One large advantage they will have is a "burning platform". This is the jargon used by "change" consultants to describe a situation where there is a visible, obvious and compelling need for change.
When you're operating in an oligopoly that generates super-normal profits and there is little threat of regulatory action there is no burning platform – complacency is the order of the day. The hope is that the Royal Commission has provided directors and executives in the industry with the burning platform they need to effect the changes that are sorely needed.