The Fed’s drive for moral leadership in bank boards

The Federal Reserve’s surprise punishment of Wells Fargo hints at its new demand for board directors to be proactive as moral managers of corporate culture.

AP Photo/file
A man walks past a Wells Fargo location in Philadelphia. The Federal Reserve is imposing more penalties on Wells Fargo, freezing the bank's growth until it can prove it has improved its internal controls. The new penalties were announced Feb. 2 on Fed Chair Janet Yellen's last day at the central bank.

The directors of financial institutions in the United States should be on high alert after a surprise move by the Federal Reserve. On Feb. 2, the regulator slapped a harsh penalty on Wells Fargo, the third-largest bank by assets, for its board’s inadequate oversight of ethical and legal risks in the company. Until the bank improves its governance and replaces some board members, it will not be allowed to grow in total assets.

“We cannot tolerate pervasive and persistent misconduct at any bank,” said Janet Yellen on her last day as the Fed’s chair.

The Fed has hinted for months that it wants better risk management by bank boards. In effect, it sees them as independent watchdogs of management, assigned to foresee problems and prevent them as well as be proactive in creating a culture of integrity. No longer can a board merely assign blame to underlings when things go wrong. Preventive action is now presumed.

“Across a range of responsibilities, we simply expect much more of boards of directors than ever before,” said Jerome Powell last August. He took over as Fed chief Monday.

Wells Fargo was likely chosen to set an example. It is still reforming its ways after being caught in 2016 for creating fake bank accounts for millions of customers and overcharging on consumer loans. But it is not alone in being the focus of public calls for more accountability.

“One defining feature of 2017 has been seeing corporate directors and officers being held personally responsible for illegal behavior at their companies,” stated the Harvard Business Review in a December article.

Volkswagen’s board, for example, still faces scrutiny over the company’s cheating on emission tests and other scandals. And the trustees of Michigan State University are fending off charges that they should have done more to prevent the sexual abuse of young female athletes by gymnast doctor Larry Nassar.

In its new demands on bank boards, the Fed is not going as far as the central bank in Hong Kong, which has proposed that banks set up a special committee for ethical conduct in corporate culture. Still, banks may be left wondering what further steps are needed to head off adverse surprises by their managers and employees.

Merely selecting highly moral directors for a board may not be enough. Such members may be role models or even help write good ethical codes. But are they probing company practices, encouraging employees to speak frankly, and otherwise promoting good values and being a moral manager?

And it is not only top leaders that need to be proactive. “In hierarchical cultures, it is critical to empower employees at all levels to speak up and take action,” says the Harvard Business Review article.

Such diligence in upholding a company’s ethical practices requires foresight to recognize potential problems and then act to prevent them. Like many corporate boards, the board of Wells Fargo missed warning flags about bad practices. Its new directors are racing to learn skills in moral leadership. The Fed would just like them to move faster.

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