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Good governance: the key foundation to a successful new bank

Good governance has an impact to a broad range of key decisions that any bank will need to make, including strategic initiatives, financial performance, risk management, outsourcing and remuneration among other items. For new banks in particular, we have observed that a robust governance framework will help strengthen the firm’s long term viability and ability to navigate through potential future headwinds. The initial years after authorisation are particularly challenging as new entrants navigate business growth to achieve profitability and additional regulatory scrutiny without taking on undue risk in a concentrated marketplace. Taking the time at the outset to design an appropriate culture and governance arrangements with a long-term view, can help applicant firms to deal with challenges later on once authorised and have a stronger relationship with the regulators.

Indeed, one of the key tests during the new bank authorisation process is meeting the governance and culture expectations set by the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA). The regulators have a limited window to assess the business model and operations of an applicant firm and, therefore, the strength of governance arrangements can be a key factor in the application. Weak governance is regarded by regulators as an underlying cause of past failures in established banks. For example, Andrew Bailey, Governor of the Bank of England, has previously remarked:

“My assessment of recent history is that there has not been a case of a major prudential or conduct failing in a firm which did not have among its root causes a failure of culture as manifested in governance, remuneration, risk management or tone from the top.”1

Evolution of governance expectations: from pre-application to full authorisation

 

The PRA takes a proportionate approach to regulation – one that will be further strengthened with the finalisation of the new Strong and Simple framework. Nevertheless, governance arrangements appropriate for a firm in pre-application will be very different to those for a well-established authorised bank. A strong application will include a demonstration that the applicant understands the importance of good governance and has intention for the governance arrangements to mature in line with planned business growth. For example, where a new strategic initiative is being assessed, consideration should be given to whether existing governance arrangements would require enhancement to ensure adequate oversight.

The timeline below provides a high-level summary of the evolution of governance expectations at different stages of a firm’s lifecycle based on recent PRA publications.2

Image 1: Evolution of regulatory governance expectations3

Although the PRA has set out its general expectations through the authorisation lifecycle, these should be adjusted by applicants to be firm-specific based on their business model, strategy, risk profile and planned growth. Indeed, best practice would be to aim to enhance governance arrangements ahead of planned business growth.


Role of the Board

 

A strong and effective Board is key for both new and established banks. At the early stages of a new bank, the Board has a critical role to play across a number of key areas. This typically includes:

  • The Board of all banks has a leading role in setting a strong risk culture and tone from the top. At the start of the application process, applicant firms have a clean canvass to design and implement governance arrangements and cultural expectations that deliver strong prudential and conduct outcomes.
  • The Board also has a key role in setting the business strategy for the firm. Whilst it may be tempting to focus on immediate authorisation-related matters, a strong Board of a new bank applicant firm will also consider the medium- and long-term horizon.
  • The Board will ultimately be responsible for overseeing the hiring plan of key staff members and for articulating a clear route to delivering Board independence. The regulator will expect to see clear Board involvement in key decisions regarding the hiring plan and path to independence.
  • Boards should also be cognisant of regulatory priorities (and the corresponding required skillsets and expected Board oversight) that, even if not currently an immediate focus for the firm, will become increasingly relevant as the firm progresses to full authorisation. This could relate to key PRA supervisory priorities, the FCA’s Consumer Duty, ESG and managing the risks arising from climate change and Basel 3.1 changes.


Common challenges for firms

 

Investing in the correct balance of Board skills and experience

Although the challenge of attracting individuals with sufficient skills and experience is felt across the banking sector, it can be more acute in the new banks sector with greater budget constraints. When building out both the Executive team and Independent Non-Executive Directors (INEDs), consideration should also be given to the range of skills and experience which may be needed to ensure sufficient review and challenge of key decisions. The diagram below lists a non-exhaustive range of potential skills and experience that may be identified as necessary for the Board collectively to hold.

Image 2: Indicative summary of Board-level skills and experience mix

Where a gap in skills or experience has been identified, a clear plan for recruitment should be developed to ensure the applicant has an appropriate Board composition for authorisation.

Keeping up with the evolution of required skills and requirements

The skillset required when a new bank is at a conceptual or pre-application stage is typically quite different to those skills relevant for a bank that has been authorised for five years. For example, at the initial stages of the authorisation process, firms typically require individuals with strong entrepreneurial skills to deliver the business proposition, with these individuals typically covering a range of different roles. However, as the firm grows and matures, the delineation of key roles may become more defined and specific skillsets may need to be added to the Executive team or Board. In particular, the evolution of the governance structure should be considered in line with evolution of the risk management structure.

Shareholder NEDs: managing conflicts of interest

At the early stages of a new bank, the PRA acknowledges that the Board is unlikely to be independent and will include individuals with potentially large shareholdings (such as co-founders with senior Board/Executive positions or shareholder appointed NEDs). As such, there can be circumstances where decisions related to the firm are influenced by a secondary interest.

While the regulators are cognisant of the challenges of a new bank, the Board should be majority independent within five years post-authorisation. The applicant firm should consider the evolution of the independence of the Board within its business plan and ensure there is a clear Conflicts of Interest Policy to ensure such conflicts can be detected and mitigated as required.

Achieving Board diversity

Maintaining a Board composition that is diverse is a key step to ensuring that there is an appropriate range of perspectives and challenge at the Board. As well as skills and experience, diversity should extend to ‘cognitive diversity’ and bringing in different styles of thinking. The regulators’ proposals on Diversity and Inclusion in the Financial Sector sets out key considerations a new bank applicant firm should consider when planning Board and Executive recruitment.


Next steps

 

The governance framework can sometimes be an area of the authorisation process that is overlooked by new bank applicant firms. However, it is a crucial element of the regulators’ assessment and has been a priority area for the PRA for a number of years. Strong governance helps firms achieve longer-term viability and ensures an appropriate tone from the top. This in turn feeds into enhanced business performance and helps the firm in question meet key regulatory expectations. Key items to consider could include:

  • A long-term plan for the ongoing enhancement of governance structures and oversight arrangements to meet the regulator’s evolving expectations throughout the authorisation lifecycle,
  • A clear recruitment plan to ensure key positions are filled at the appropriate time and an adequate range of skills, experience and independence is in place, and
  • The appropriate tone and risk culture are set from the top at the outset of the authorisation process.

If you would like to discuss any of the insights presented here, please contact any of the authors listed below. In addition, would may also with to visit our New Bank Start-Up Page where other insights are discussed in more detail.

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References

 

1 Culture in financial services – a regulator’s perspective, May 2016

2 New Bank Start-Up Unit | Bank of England and Non-systemic UK banks: The PRA's approach to new and growing banks (bankofengland.co.uk)

3 Source: New Banks Start-Up Unit and Deloitte industry observations

Meet the author

Henry Murdoch

Manager

Manager in Deloitte’s Investment Management & Wealth Prudential practice, with experience of both PRA and FCA prudential handbooks. Current focus areas include ICARA process, prudential consolidation, capital/liquidity assessments, risk management frameworks, wind down planning, stress testing, governance/oversight and prudential due diligence for M&A transactions. Our recommended pages can be found below :  Is your stress testing and risk appetite framework adding value to your business? IFPR: Observations and current expectations one year on FCA Dear CEO Letter 2023 to Wholesale Broking Firms

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