The boards of financial firms will have to ensure they have financial experience, expert advice, more internal independence, and a better handle on their risk appetites, says Canada’s top banking regulator.
Speaking to the Toronto Board of Trade on Thursday, Julie Dickson, head of the Office of the Superintendent of Financial Institutions, spelled out some of the reforms OSFI is looking to bring to corporate governance at financial firms. Dickson said that OSFI is using the results of a comparative review of governance practices that it carried out last year to update its governance guidelines for financial institutions. The revised guidelines are expected to be available for comment by the summer.
In her speech, Dickson singled out three main areas where firms can expect the governance guidelines will be made more demanding: board composition, third-party reviews, and the focus on risk appetite.
In terms of composition, she said that OSFI will be demanding that board members have relevant financial industry expertise, in addition to their skills. This is necessary, she said, because the business of financial institutions is quite distinct from other types of corporations. And, the regulator believes that each financial institution “needs an extra pair of informed eyes focused on management and on operations, particularly with respect to risk.”
Second, she said that in order to assess management, boards need information about best practices. And so, OSFI will be expecting boards to commission third-party reviews of a financial institution’s oversight functions. This, she said, “will help board members to benchmark the institution’s risk management practices and processes.”
OSFI will also be calling for the separation of risk and audit committees in complex institutions to allow for an increased focus on both areas.
And, finally, OSFI also plans to add a new concept to the guidelines related to the role of the board in approving risk appetite.
“This issue is not just about documenting a risk tolerance statement – it is also about embedding many different ways within financial institutions to test whether things can happen that would cause them to exceed their appetite for losses – to help overcome the notion that ‘that could never happen’,” she said.
“Establishing risk appetite is a multi-faceted exercise that involves setting the tone at the top and the bottom of the organization to identify risks, accept risks, manage risks, discuss risks, monitor risks, and elevate scenarios that, while highly unlikely, would cause material losses. Sometimes bad news, or straight talk about risks, does not travel upwards; it must. And boards must insist on this happening,” she said.
Dickson said that OSFI is conscious that it must not overload boards, or blur the line between management and boards too much, so it is also currently assessing “all the things we ask boards to do to see whether any current requirements are inappropriate”.
Changes to mortgage underwriting practices
In her remarks, Dickson also addressed OSFI’s recently released draft guideline on sound mortgage underwriting practices. She said that in the future, senior management will have to provide a declaration to the board that the financial institution is in compliance with the OSFI guideline.
“This was added because we had noticed cases where board approved polices were not being followed,” she said.
And, given the well-documented vulnerability of Canadian household debt loads, mortgage lending is an area where OSFI wants to ensure adequate board oversight.
“In a world where international agreement can be difficult to reach, there is one thing on which all countries agree: boards of directors are ultimately responsible for the oversight of management and overall risk governance of financial institutions. The job of the board is challenging, especially in light of today’s environment when judgments about risk-taking can be so challenging. In such a climate, the role played by boards of directors is all the more crucial,” she concluded.