May 2021

The COVID-19 pandemic has generated significant instability in the global capital markets, and the banking sector has been one of the most affected. However, unlike in other crises (most significantly the global financial crisis), this crisis did not begin in the financial sector –as we being to emerge from this global pandemic it is becoming clearer that banks this time will have an important role in actually supporting in the recovery process. To achieve this, and as public support measures are lifted, banks will have to embrace the lessons they have learnt over that past year, be it shifting to more digital technologies, increasing cost-efficiencies, or exiting markets of players without sustainable busines models.

All these challenges – and opportunities – for banks call into question the management and governance of banks, and how they appoint suitable board members in order to navigate through and beyond the crisis. Inadequate governance and diverging national standards are becoming increasingly less tolerable and the ECB continues its watchful eye on this - in its Supervision Newsletter in November 2020, the ECB states “Robust governance is one of the cornerstones of the sound and prudent management of supervised credit institutions”. To this end, it announced that: “The ECB wants to be more transparent about its supervisory expectations regarding the quality of appointees […] the ECB plans to publish a revised handbook to replace the current Guide to fit and proper assessments in 2021”. So what are the intentions of the ECB, and what does this mean for banks?

More intrusive suitability assessments

In a recent speech at the European Parliament in March 2021, Andrea Enria, chair of the ECB’s Supervisory Board, clearly outlined that he expects the ECB to make three main improvements to the current fit -and -proper system:

  • Early engagement with supervisory teams
    • The enhanced Guide will recommend that banks should inform the ECB of suitability assessment before making appointments, irrespective of the ex-ante or ex-post nature of national regulation.
  • Greater consideration to supervisory findings that relate to positions previously held by candidates
    • If shortcomings have arisen in the past, the ECB will attempt to trace back to individual responsibilities of board members, rather than the board as a whole, in terms of either actions (or inactions).
  • Reassessing board members should new relevant facts emerge
    • More detailed guidance will be provided on how the emergence of new material facts could affect the suitability of board members, including in the space of money laundering risks.

To support this initiative, the ECB itself has made internal adjustments to its own organisation and processes to prepare for such a change in supervision. Within the new Directorate General SSM Governance and Operations (DG/SGO), there will be a dedicated division for fit and proper. Furthermore, the FSB outlined in a recent report how the ECB is using natural language processing and machine-learning to automate the translation and assessment of around 3,000 fit and proper questionnaires received annually, and now is exploring how to deploy this tool more widely based upon this proof of concept. This reorganisation combined with new artificial intelligence tools will allow the ECB to therefore focus on the qualitative aspects of suitability assessments, rather than laborious manual data recording activities.

Aside from these more concrete deliverables, the ECB has recently made statements that suggest that they will be focusing more on diversity within management of banks – in a February 2021 speech by Edouard Fernandez-Bollo, Member of the Supervisory Board of the ECB, he stated: “Diversity within a management body is […] crucial: it is not just a fad, it is a global trend that has gained pace because the world has started to fully understand the benefits it brings”. Quoting a benchmarking exercise of 834 credit institutions and investment firms by the EBA, he noted that “two thirds have executive directors of only one gender and 40% have not yet adopted a diversity policy at all, despite the provisions of the CRD IV. This situation is simply not acceptable to us as supervisors”.

What does this mean for banks?

The ECB is clearly raising the bar for suitability assessments of board members, both by acknowledging the future publication of revised expectations as well as in their own organisational changes, use of sophisticated tools and by embracing the global trend of diversity. What remains clear is that the primary responsibility for assessing and ensuring the suitability of the management body and members is with banks themselves - not their supervisor. In order to therefore minimise disruption, banks should consider the following measures:

  • Enhance the frequency and methodology for reassessing board members
    • Though an annual frequency is not yet mandated, we would recommend that banks should consider performing activities around a fit and proper reassessment, such as documenting changes in the past year, or how this may or may not impact their ability to carry out duties (as the UK Senior Manager and Certification Regime requires currently).
    • Define and document criteria by which individuals could require a revised suitability test (E.g.: in the case of a particular enforcement action, negative press activity, change in risk profile of the bank).
  • Enhance internal processes and procedures around fit and proper
    • Banks should revisit their internal processes to ensure suitability assessments can be conducted on a timely basis, and potentially at an increased frequency.
    • In addition, as we expect more intrusive assessments going forward, banks should be ready to dedicate appropriate senior management time to this process.
  • Revisit diversity policies of the organisation
    • As the ECB has noted, some banks lack of diversity will no longer be acceptable for supervisors, nor is it compliant with the CRD IV.
    • Banks should therefore prepare for future dialogues with their supervisors on how diversity will help them face current challenges, as indicated by Edouard Fernandez-Bollo.

Conclusion

As stated by the ECB, we expect the revised handbook to replace the current Guide to fit and proper assessment to be published in the near future. This should help banks gain a better understanding of what is expected before making appointments, predict the outcome of suitability assessments and increase the efficiency of the overall assessment process. But as Enria noted in his speech to the European Parliament, it is not all plain sailing: “Internal governance is a key factor in banks’ ability to overcome the challenges ahead. It is also at the core of our supervisory review and evaluation process (SREP) and this is the area where we have more findings and need for follow-up actions than in any other area”. As noted before, the banking sector will play a critical role in the post-pandemic recovery process – it is important that boards are ready to face up to the challenge.

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