The PRA has published a speech given by Andrew Bailey (Chief Executive, PRA). The speech is entitled Governance and the role of Boards.

In his speech Mr Bailey mentions that the PRA has close contact with many boards and in relation to what supervisors expect of boards three things stand out for him:

• the PRA expects the board to exercise good judgment in overseeing the running of the firm and to do so on a forward-looking basis;
• that judgment is improved by good constructive challenge from non-executives. A firm’s culture should promote discussion, debate and honest challenge. The alarm bells ring for the PRA when it is told that the CEO or other senior executives are very sensitive to challenge; and
• the PRA depend on non-executives, under the leadership of the chairman, to challenge the executive in all aspects of the firm’s strategy, which includes the viability and sustainability of the business model and the establishment, maintenance and use of the risk appetite and management framework. The PRA also relies on the non-executives to mentor and coach the executives and balancing this with the essential ability to challenge is a vital component of an effective board.

Mr Bailey states that in terms of the senior managers’ regime, the above frames the responsibility of boards. However, he acknowledges that many board members have said to him “if only it was that simple”. Mr Bailey then asks the question as to how responsibilities can be squared with the complexity stating that the key challenge is to be able to boil the complexity down to understand what are the key drivers – which judgements are likely to matter when bad things happen in the tail of the distribution of risks.

Mr Bailey states:

“So, let me put forward a proposition for boards. It is the job of the executive to be able to explain in simple and transparent terms these complex matters to non-executives. In doing so, you should understand the uncertainty around judgments, in what circumstances they could be wrong, and how there can reasonably be different ways to measure things like liquidity. Non-executives should not be left to find the answers for themselves, and they should not feel that they have to do so out of a lack of sufficient confidence in what they are being told. In other words, they should not be pointed towards the haystack with warm wishes for the search ahead.”

Mr Bailey then gives an illustration relating to internal risk models and what a board needs to understand. He states:

“Try the following:

• key elements of model design;
• significant assumptions and expert judgements;
• key sensitivities; and
• significant limitations and uncertainty in the model.

To restate, the challenge is to reduce complexity to simplicity, so that board members feel that they understand:

• where is the model expected to work well;
• in what circumstances is it likely to break down;
• is the overall model output credible;
• what “moves the dial” in terms of key assumptions or judgements; and
• are those assumptions and judgements reasonable?”

He adds that:

“None-executives should be put in a position to possess a general understanding of the model and meet these expectations without detailed technical knowledge. That’s the job of the executive, to explain complexity, provide good management information and enable challenge and thus accountability. If non-executives do not feel that they can meet these expectations, they should demand the time and support to enable them to do so, rather than head off for the haystack.”

View Governance and the role of boards, 3 November 2015