12 June 2024

CEPR's Hau, Radach, Thum: Insufficient supervisory board competence as a risk factor for banks

The Credit Suisse crisis illustrates how poor governance can lead a large bank into a crisis despite compliance with capital requirements. Recent research on supervisory board competence in banks has provided interesting new insights.

This column updates an index of supervisory board competence for a sample of German banks and compares their performance in 2023 versus 2008. Although competence measures have improved for most banks, large gaps remain across banks and also between public-sector and private-sector banks. Bank supervisors should systematically measure, track, and report bank board competence and its alignment with a bank’s business. 

The global banking market is once again experiencing turbulent times. Following two bank failures in the US, Credit Suisse, one of the major European banks, suffered a liquidity crisis in March 2023 after a decade of both poor governance and disappointing performance. In his book on the failure of Credit Suisse, Swiss financial journalist Dirk Schuetz (2023, p. 57) makes the following assessment of the appointments to the Board of Directors in 2015: “Roche boss Severin Schwan was appointed as the new Vice Chairman [of Credit Suisse], a proven pharmaceutical expert without in-depth financial knowledge. Or Silicon Valley entrepreneur Sebastian Thrun: a luminary for self-driving cars but hardly for ailing balance sheets. [...] For the first time in history, probably the wildest of all major global banks was led by two non-bankers - and the banking expertise on the Board of Directors was meagre. And the supervisors from FINMA nodded off all personnel decisions.”

Is the lack of financial expertise on the board of Credit Suisse and its ultimate failure a pure coincidence? Or is supervisory board competence an important factor in determining long-term bank risk?

Study results on the 2007/08 banking crisis

From a legal perspective, a competent supervisory board is responsible for ensuring that competent managers on the management board have the day-to-day business under control, that the right incentives are in place at the bank level, and that a business model is pursued with a sustainable balance between profitability and risk. To fulfil these tasks, however, the members of the supervisory board must also understand the banking business, and particularly the complex products and risks in the global financial markets.

However, banking and financial market expertise is by no means a given. During the financial crisis of 2007/08, we were able to show in a much-cited study that the competencies of the supervisory boards of German banks differed greatly (Hau and Thum 2008, 2009). The more competent the supervisory and administrative boards were, the lower the average losses suffered by a bank during the financial crisis (Figure 1). The differences between private and public-sector banks were striking. The boards of directors of many public-sector banks lacked a deeper understanding of complex financial products, which also explains the disastrous performance of Sachsen LB, Bayern LB, and HSH Nordbank....

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