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Effective Governance of Financial Institutions

Effective Governance Strategies for Financial Institutions

by Dustin Abad on and last update on September 23, 2020

There is a lot of risk in governing financial institutions. On one hand, they make a lot of critical decisions concerning money. On the other hand, their stakeholder is the general public.

Because of this, the governance of financial institutions requires stricter check-and-balance systems. The board has a pivotal role in the governance of financial institutions. To give direction, they make crucial decisions for the entire institution. As such, they heavily influence the success or failure of an institution.

To ensure success, the board should efficiently work hand-in-hand with the management, ensuring they uphold both private and public interest. This is also key to ensuring compliance to the policies that regulate their organization. All of these should be considered while striving to be innovative.

Below are some steps on how to effectively govern over financial institutions:

1.  Accompany Hardware with Software Governance

The financial sector is one of the most heavily regulated sectors. Although there are policies set, boards of financial institutions should not limit themselves to box-ticking.

The New York Federal Bank points out that financial crises are born out of the individual decisions of its leaders, operating within the set laws, regulations, and tax codes. For instance, the 2008 financial crisis revealed that some boards lacked experience. Some boards were also too closely tied to the bank that they failed to see the gravity of the risks that were being taken.

Therefore, the leadership, skills, and behavior play an even bigger role. Here are questions that need to be asked by financial institutions:

  • How does the board engage, challenge, and support the management and everyone involved in leading the organization? Is the relationship a constructive one?
  • Are the interactions transparent and open?
  • What are the underlying culture and values that drive behavior? How is the desired culture reinforced?

Hardware and software must complement each other for effective governance. Guided by policies and regulations, leaders must ensure that the activities of their organization positively impact the institution and the public. Leaders of financial institutions should put constant effort in reviewing guidelines and procedures, as well.

2.  Think Long-Term over Short-Term

Focusing on short-term goals over long-term ones has been a constant problem in financial institutions.

Although it is understandable to focus on the here and now, studies find that financial institutions favor short-term gains over long-term benefits.

In a study conducted by Harvard Law School, the researchers observed that incentives are only rewarded for short-term results. Top-level management and employees, in turn, developed a narrow mindset. They only think about the short-term impact of their decisions and actions.

Effective governance requires leaders to go beyond this way of thinking and give weight on long-term value creation. To do this, leaders of financial institutions ought to exercise prudence and value innovation. Various cases in history have proven this.

The invention of the ATM, for example, took around 18 years. Even then, there were several problems regarding security and technology. Leaders who were looking only at the short-term would have never realized the benefits of the ATM. They would have only seen the immediate setbacks and decided not to pursue it.

But, capable financial institution leaders had their eyes set on the future. They knew that the ATM would positively impact the customer experience. Half a century later, we are still reaping the benefits as ATMs have become an integral part of the banking experience.

3.  Invest in Innovation

By 2025, McKinsey estimates that legacy banks and financial institutions will experience up to 60% decline in profits if they do not catch up with FinTech companies.

With the COVID-19 pandemic speeding the need for businesses to go digital, banks are scrambling to get their services online. However, bringing banks, credit unions, insurance companies, and other similar companies to the digital age is not enough to modernize banking. Technology can help financial institutions navigate risk management, improve customer experience, and enhance revenue streams. However, financial institution boards must recognize it as a tool and not the ultimate end goal.

Instead, leaders must focus on innovation–reinventing and evolving the governance and the institution from the inside out. Financial institutions need visionary leaders to be able to surpass and thrive in the fast-paced evolution of the digital age. It is these leaders that will take the necessary risks that will bring long-term success.

If the focus had just been on technology, the ATMs would not have existed now. In fact, in the 1980s, the ATM could not catch up with the development in computing and electronics. Visionary leaders thinking long-term saw this as an opportunity for growth and collaborated with engineers and users to make better machines. Even up to now, we see the ATM is constantly evolving to meet the demands of the times and consumers.

Focusing on innovation means leaders of financial institutions are working toward constant growth, collaboration, and the future.

People Dictate Governance

Risk is an inseparable part of financial institutions, but it shouldn’t limit their governance.

Good governance relies on the people, specifically the leaders, for a holistic banking system. Leaders with a long-term and innovative mindset will keep financial institutions growing into better, stronger industries prepared for the future.

Governance and Leadership
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