01.12.2024Bank governance: More than just compliance

Reputation and trust are crucial for long-term success, and active governance is a key factor in achieving this. Small and medium-sized banks face the challenge of not only formally complying with regulatory requirements, but also using them as a basis for proactive and responsible corporate governance. This enables them to secure the trust of customers and other stakeholders in the long term and remain successful in the market.

One – or even the most important – pillar of a bank's business model is trust in it. For this reason, banks often use a long-past year or a medieval castle or fortress in their communications or logos – something that conveys stability and security. After all, people entrust their money to these institutions and, in some cases, become dependent on them when they take out loans.

Logos and dates are reminders of times gone by and are of little help in a crisis of confidence in the present. Examples such as Banca Monte dei Paschi di Siena, a financial institution founded in 1472 that only escaped bankruptcy thanks to a stake taken by the Italian government, or Credit Suisse, founded in 1856 and now part of UBS, illustrate this point. Nowadays, intangible assets such as a company's reputation, patents or brand account for up to 90% of the market capitalisation of listed companies. Given that reputation and brand in particular can react very sensitively and quickly to news in traditional media such as newspapers or new media such as X or Instagram, it is clear that a considerable part of a company's market value is constantly ‘at risk’. Banks are disproportionately affected by this, as intangible assets such as reputation, intellectual capital, customer networks and technological innovations are key drivers of their business model and, unlike industry, they have relatively few real assets or patents that can be used as collateral in an emergency.

Smaller and medium-sized banks in particular, which often face intense competition for customers and market share and are not very differentiated geographically – and usually also in terms of customer segments – are particularly dependent on their reputation. In a sector where a small loss of trust can quickly lead to a critical ‘bank run’, a financial institution's reputation is its key asset.

Accordingly, sound and actively practised corporate governance is essential in these small to medium-sized banks. This is true even if, due to their ownership structure – be it the county, a family or a partnership – they are not directly exposed to the pressures of the capital market in the same way as large, listed institutions. Corporate governance describes the basic rules and processes by which a company is managed and held accountable. Especially when, as mentioned at the outset, a company is heavily dependent on intangible assets and public trust, it is crucial that governance principles do not just exist on paper, but are actively practised by the board of directors. This includes, in particular, the board regularly questioning and challenging itself. Do we have the right experience and knowledge on the BoD to credibly implement the strategy we are pursuing and be a valuable sparring partner for the management? Are we working together efficiently enough and using the limited time available on the board to discuss the right topics? Are we open to new ideas and sufficiently familiar with global developments? It is often not easy to ask these questions objectively within the board. One possibility, and an increasingly common method, of doing this systematically is to conduct an externally supported board evaluation. With the help of an independent third party, these questions are examined individually and objectively and then discussed by the entire board.

The boards and management teams of small and medium-sized banks face significant challenges and are required to actively invest in good governance. This involves not only making their own actions as effective as possible, but also reconciling the interests of various stakeholders – including shareholders, customers, employees and society – in order to work together, with proverbial ‘combined strength’, towards the strategic goals and purpose, i.e. the raison d'être, of the institution.

The Swiss Financial Market Supervisory Authority (FINMA) is also aware of the importance of sound corporate governance and therefore imposes additional requirements on financial institutions with regard to corporate management. These go beyond the general provisions of the Swiss Code of Obligations and include specific requirements for internal organisation, risk management and the independence of supervisory functions. The aim of these additional requirements is to ensure the stability of the financial system and to strengthen public confidence in the governance of banks.

However, even though FINMA requirements are far-reaching, they are merely minimum requirements. Financial institutions often view them as a kind of checklist that needs to be worked through. This compliance-based approach may satisfy legal requirements, but it often falls short when it comes to protecting intangible assets such as reputation and trust in the long term. Most of the governance structures of failed financial institutions were at least compliant with best practice on paper. However, a tick-box mentality usually means that formal requirements are met, but the underlying philosophy of corporate governance is not integrated into daily practice.

In order to protect the reputation of a financial institution in the long term, it is therefore necessary to understand corporate governance as an integral driver and pillar of corporate strategy. Corporate governance must be practised actively and proactively. This requires the board of directors, management and the company in general to have high ambitions in terms of transparency, ethical conduct and a willingness to take responsibility. Proactive and responsible corporate governance can build trust among customers and the public.

Owners play a key role for small to medium-sized banks, as these are often less diversified and therefore less resilient than their larger counterparts. The traditional focus on owners, i.e. the interests of (majority) shareholders, alone is not enough to secure long-term trust in a bank and ensure sustainable corporate governance. Rather, it is essential that the interests of all relevant stakeholders are taken into account and incorporated into the corporate governance strategy. Who are these stakeholders, why are they relevant, and how can an effective dialogue be conducted with them?

Customers are undoubtedly one of the most important stakeholder groups for a bank. For small and medium-sized banks, which often rely on a local or regional clientele, maintaining customer relationships is essential. Customers entrust the bank not only with their financial resources, but often also with their future planning or business goals. The bank's reputation depends largely on how well it understands and meets the needs of its customers. A loss of customer trust can have a direct impact on business activities and, due to the local focus, can in extreme cases threaten the bank's existence.

Regional financial institutions or those focused on a specific customer group must therefore keep an eye not only on their own risks, but also on the risks of their largest customer segments. For example, is a region or industry particularly vulnerable to higher interest rates or geopolitical or climatic changes? Long-term thinking management bodies try to work with customers at an early stage to find solutions that enable greater resilience to such changes and thus a long-term business relationship.

Bank employees are not only the ‘public face’ of their bank, but also important ambassadors of its corporate culture. In small to medium-sized banks, the majority of employees often have direct contact with customers, both professionally and privately, and therefore play a key role in shaping the public perception of the bank. A motivated, well-trained and actively involved team is therefore the key to success.

Dialogue with employees should be based on a culture of openness and mutual trust and, as far as possible, be proactive. Transparent communication with employees can help to avoid uncertainty and rumours. In addition, involving employees in the development of the company's purpose – or initiatives to implement it – can help to foster a strong commitment to the company and a close connection to its identity.

Compliance with legal and regulatory requirements is of great importance in the banking sector. Supervisory authorities such as FINMA ensure stability in the financial system and protect the interests of investors. For small and medium-sized banks, regulatory requirements can pose a particular challenge, as they often have fewer resources than large banks to implement complex compliance regulations. At the same time, a good relationship with supervisory authorities is essential to maintain trust in the financial institution and its credibility.

Dialogue with supervisory authorities should be regular, transparent and constructive. This also helps to avoid misunderstandings or even sanctions with this stakeholder group and shows that the bank takes its obligations seriously. It is important for the bank to proactively report on its business activities and compliance efforts and, in return, to clearly understand the requirements and expectations of the supervisory authority.

As mentioned above, small and medium-sized banks are often strongly rooted in their local communities. They contribute to the economic development of the region, create jobs directly and indirectly, and offer financial services tailored to local needs. A financial institution that is seen as a responsible member of the community will be able to count on the trust of the population even in times of crisis. Part of this responsibility increasingly concerns sustainability, i.e. social and environmental issues.

Dialogue with society should therefore take place at the local level in particular. If there is a lack of public awareness of social engagement, the local community may conclude that the bank does little for the region and thus acquire a reputation for being ‘aloof’ and insufficiently rooted in the region.

Although they are not the only relevant stakeholder group, shareholders naturally play a central role in corporate governance, as they provide the capital for the bank's business activities. They therefore have a legitimate interest in ensuring that the bank is managed responsibly and generates long-term returns. Striking a balance between short-term profits and long-term stability is a particular challenge in this regard.

This requires transparent and honest dialogue with shareholders. Regular direct discussions with the largest shareholders – often cantonal representatives in the case of medium-sized and small banks – about governance structures and the bank's long-term strategy are essential for building trust. It is also important that this trust is built up in good times and that contact is not only sought in times of crisis.

Sound corporate governance is not only a legal requirement for small and medium-sized banks, but also an important competitive factor. It creates the basis for building trust and helps to protect the bank's reputation. The board of directors plays an important role as an active driver of stable and forward-looking governance. It is called upon not only to regularly review its own efficiency and effectiveness, but also to strive to achieve a composition that enables it to address current and upcoming challenges professionally and with the necessary expertise.

Furthermore, governance should not focus solely on shareholders, but should involve a broader group of different stakeholders. Each of these groups – from customers and employees to supervisory authorities and the local community – contributes in its own way to the success and stability of a bank. Open, transparent and active dialogue with these stakeholders is necessary to build and maintain trust. Only by incorporating these interests into decision-making and risk management, and through forward-looking communication, can the bank's reputation be protected in the long term and the company be managed successfully.

Dr Christoph Wenk Bernasconi is a lecturer atExecutive Education Finance and programme director of theCAS in Stakeholder Management and Stewardship at the University of Zurich, as well as a partner at SWIPRA Services and Trusted Board Advisors (TBA). His areas of expertise are corporate governance and sustainability. He combines more than a decade of applied and academic work in this field. In his work at SWIPRA and TBA, he advises boards of directors and management teams on various corporate governance issues.

This article originally appeared in "Recht relevant. für Verwaltungsräte 4/2024"