PUBLISHED IN NJ BANKER, DIRECTORS’ CORNER

PAUL AGUGGIA | PARTNER | HOLLAND & KNIGHT STUART R. LEVINE | CHAIRMAN & CEO | STUART LEVINE & ASSOCIATES

In May, the Office of the Comptroller of the Currency (OCC) released its Semiannual Risk Perspective for spring 2019 outlining major themes and risks for the federal banking system. Like previous reports, this report discusses the  complex environment in which banks must operate, and thus is a helpful guide for all banks assessing risk. It notes

key drivers for operational risk, including cybersecurity threats, innovation in financial products and services, and the increasing use of third party platforms to provide and support operations that might not be effectively understood and implemented. This report, however, is particularly insightful (and challenging) in its focus on the impact that advances in technology can have on security concerns, customer expectations, overall strategy and on a broader level, effective implementation of desired strategies.

The OCC highlights potential advantages financial innovation can provide to the banking industry; technology and artificial intelligence allow banks to introduce new ways to meet customer needs, improve operating efficiencies and increase revenue. Programs utilizing data analytics and other predictive services increase efficiency and are becoming increasingly common within the banking system. Of particular relevance for all regional and community banks, the report addresses innovation and its related impact on strategic risk, noting the elevated levels of strategic risk for many banks. In summary, the report points to the challenges posed by the accelerated pace of change in innovation and rapid developments within the industry, coupled with evolving customer preferences and the  popularity of mobile banking applications.

The report’s emphasis on technology and innovation somewhat subtly advances the thesis that a bank’s failure to keep pace with rapid changes in the industry could prove fatal. Far less subtle in commenting on this topic was entrepreneur Adam Dell, founder of personal finance app Clarity Money (bought by Goldman Sachs), who said: “There are two kinds of incumbent banks: There are banks that are screwed and banks that don’t know they are screwed.”

Whether or not you choose to subscribe to that thesis (which we do not), the issue of strategic risk in today’s environment must be front and center in the boardroom. This is particularly true for smaller banks struggling to compete with banking giants in a changing environment. Currently, the median efficiency ratio is elevated for smaller banks with total assets under $500 million. The stratification of efficiency ratios indicates a clear advantage in economies of scale as total assets increase. Larger banks are most capable of investing directly in the technology, staff and controls to develop and introduce new products and services. In contrast, smaller banks that are slow to adapt to industry changes are exposed to increasing strategic risk, lessening their ability to compete. Yield curve compression and inversion only highlight the severe operating challenges confronting all banks in a rapidly changing marketplace.

The implications of the report go beyond the need for banks to guard against cybersecurity and implement new technologies. The elevated level of strategic risk for many banks raises existential concerns; it speaks to more pressing and imminent issues regarding the viability of banks with management and/or boards unable or unwilling to keep up with the accelerating pace of banking technology.  Increased risk places strain on small banks already struggling to compete with their larger counterparts. Without good corporate governance effectively applied to the area of strategic risk, these banks will be unable to adapt to the change necessary to remain viable. Put bluntly, strategic risk threatens an erosion of what boards and management have built and will impact effective strategic implementation, including: inability to attract talent; inability to compete; inability to grow; inability to satisfy customers; and inability to create value.

Good corporate governance must include effective assessments to mitigate strategic risk. Given current market conditions and prevailing trends in escalating customer expectations, technological innovations and regulatory considerations, it may be prudent for boards of banks to view the effective assessment and mitigation of strategic risk as a process inherent in and essential to good corporate governance.

An effective process for board assessment is frequently driven by awareness of a bank’s position in the marketplace and the evolving needs and expectations of its customers.  Several questions are generally encountered in this analysis, such as: Does your board have the capacity to engage in strategic conversations related to a significantly changing world? How does the board prioritize deployment of capital as it pertains to risk factors such as organizational culture, employee engagement, talent, succession planning and technological disruption?

Strategic planning must become a highlevel inclusive process based upon research and data to ensure that strategies are developed collectively. Without a smart and focused strategic planning process that occurs more frequently than every two or three years, organizations cannot truly succeed today. Strong corporate governance must have greater focus on linkage with the CEO’s strategic dashboard to ensure alignment.

To complicate matters, the OCC spring 2019 report indicates that we can expect to see an increase in mergers and acquisitions.  These need to be well-planned and executed, with organizations needing to be prepared for effective change management, operational resilience when implementing new products, services and technologies, while at the same time maintaining existing operations.  Establishing the right cultural environment to ensure these changes can take place is immensely challenging. Employees are under increasing stress, data overload, lack of engagement and understanding of strategic direction. It is incumbent on the CEO and the senior leadership team to provide the right leadership direction and strategic communication.  Engagement at the highest levels of leadership for this planning process will ensure shared objectives, ethics and values for success. In addition to potential strategic partnerships and the ability to expand products and services, operational efficiencies and financial profits, it is critical to assess future merger candidates to ensure cultural fits, ethics alignment and talent retention.

Sustainable business results cannot be achieved without effective strategic planning and implementation, improved organizational effectiveness, strengthened corporate culture based on vision, mission and values that are clearly understood and embraced, learning and training that increases innovation and creativity, and team building and alignment through stronger strategic communication throughout the organization. Boards and CEOs need to focus on all of these issues to ensure strong results. NJ