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The Risky Business of Lending Institutions: Seven Risks a Director must understand to fulfill the ‘Duty of Care’

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Linda Keith CPA 7 Risks to Understand Directors Duty of Care.pdf

Summer is coming and with it, the deadline for board ‘financial literacy’ for federally chartered credit unions. For all lending institutions, the writing is on the wall for directors.

  • How would you answer these questions?
  • How do I know what I should know about financial institution finances?
  • How do I know if I know it well enough?
  • How would I demonstrate that I have met my responsibilities in this area?

All directors of every type of board have a ‘duty of care’ that requires “such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” The idea of a reasonably prudent person does not provide for a clear-cut definition. At the very least, the director should seek information from reliable sources outside of their financial institution’s management. Banking and credit union conferences are a good source for this outside perspective. I recommend each director keep your own records of your continuing education.

Test Yourself: The Seven Risks

Regulatory agencies do give some guidance. Here is a quick quiz. Before you continue to read this article:

  • List the seven types of risks found in depository institutions that the regulators indicate are essential for a director to understand
  • Define each of the seven
  • Rate your financial institution on each (poor, fair, good, excellent) and explain why you chose that rating

I’ll give you the seven at the end of this article. Consider how difficult or easy that quick exercise was. If you are a director, do you need to understand the risks better or how to evaluate your financial institution in the seven areas?

Test Yourself: Your Board Packet

When you receive your next board packet, consider the ‘dashboard’ metrics provided. Is there information about capital ratio?  Asset growth? Loan growth? Loan to Deposits? I am not suggesting these are the best metrics for your financial institution and your board, but I am wondering what you are provided. Then consider:

  • Do you understand how that metric is calculated?
  • Is increasing or decreasing favorable for that metric?
  • If it is changing, is that movement or that direction expected or unexpected?
  • Do you know what the target is? Is there a target?
  • How and why is it important to your financial institution?
  • How and why is it important that the board consider that metric?

Whose ‘Duty of Care’ is it, anyway?

The ‘Duty of Care’ is an individual duty of each director. It is one of the things you cannot delegate to management or to other directors. Three steps toward meeting the duty of care include taking independent action to understand financial institution finances, learning about the risks you are responsible to monitor, and asking questions about the financial information you receive at board meetings.

The Seven Risks

Here are the seven risks the regulators came up with. How did you do?

  1. Credit
  2. Liquidity
  3. Interest
  4. Compliance
  5. Strategic
  6. Transaction
  7. Reputation

Linda Keith CPA

works with directors, managers and lenders of lending institutions across the country. She is a conference presenter on good governance, finance for directors, business lending and navigating through setbacks to reach success. Resources at www.LindaKeithCPA.com. Email Linda@LindaKeithCPA.com for a report on the definitions and ways to mitigate the ‘Seven Risks of Financial Institutions’.

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