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Northern Rock Bank’s Corporate Governance Case Study


The Role of the Board

In the present case, the board played a negative role in the development of the organisation. While other banks employed the conventional strategies that were less profitable but more secure, Northern Rock Bank’s board made quite risky decisions that had significant positive effects in the short-term period but were disastrous in the long run.

The board failed to acknowledge the changes that were taking place in the financial world and continued their risky operations. These practices led to the severe financial issues of the bank that could not pay to the clients. Some of the most apparent reasons for such failures is the lack of experience in the financial sphere of the board (Giles 2012).

The Directors’ Principles and Views

It is clear that the bank’s directors understood that their business model differed significantly from the conventional one. However, they deliberately took the risks as they focused on maximising profits. It is seen from the director’s past that they tended to make risky decisions. More so, in many cases, those decisions led to quite severe problems for organisations, which could make the directors more responsible.

It is difficult to state that the board knew about the exact extent of the risk as the financial market seemed balanced. Nonetheless, there are high chances that the directors knew about upcoming problems although they could have thought that those issues would be short-lived. The directors hoped that they would cope with their issues, and the public would not even learn about the difficulties.

The Decision Makers: Roles and Responsibilities

It is necessary to note that the responsibilities of INEDs were quite blurred and less regulated than those of executives, which contributed to the occurrence of the issues (MacNeil & O’Brien 2010). The chairman of the board, as well as the nominations committee, was Mathew White Ridley. Ridley was the major decision-maker and had the last word on the board.

Basically, this person was responsible for evaluating major strategies utilised in the organisation. In the case of Northern Rock Bank, the chairman lacked the necessary experience and could not estimate properly the negative outcomes of the risky practices employed. At the same time, he had been an INED for a decade before he became a chairman in 2004 (Tricker 2012). This long-term cooperation means that Ridley got used to risky practices utilised in the organisation as well as the corporate culture that focused on profits rather than security.

Another key figure was the chairman of the Risk Committee, Derek Wanless, who was also the chairman of the bank’s audit committee. The responsibilities included the evaluation of the processes associated with risk management. Wanless has quite a significant experience in banking, but he also tended to choose quite risky operations (Tricker 2012). The acquisition strategy he managed proved to be unsuccessful and resulted in considerable losses for the organisation he worked for.

Finally, Sir Ian Gibson was an important decision-maker who also failed to adequately analyse the situation in the financial market and ensure that the bank’s liquidity was secured. Gibson was the senior INED, but he was also the chairman of a well-known publisher. He was responsible for the evaluation of major strategies and processes in the organisation. It is necessary to note that he had quite limited experience in the sphere of banking as he was previously engaged mainly in the car-making industry (Tricker 2012). It is clear that the three most empowered people on the board were quite inexperienced and tended to choose risky practices. These qualities contributed greatly to the board’s inability to evaluate the changes in the financial market and make the correct decisions.

Decision Criteria

To identify the most appropriate ways to address the problems existing in the company as well as come up with ways to solve them, it is vital to identify key decision criteria. Clearly, the decisions should result in favourable long-term outcomes (Tomasic 2011). The focus on short-term benefits proved to be disastrous. Apart from that, the decisions should be consistent with the major needs of the stakeholders (Tully & Bussett 2010).

Thus, the bank’s executives boasted that they provided various innovative financial services and could increase their loans per unit of the bank’s capital (Tully & Bussett 2010). Clearly, the decision to increase the bulk of loans as well as extend the scope of services meets prospective clients’ needs, but these fail to meet the need for security of the existing customers. Likewise, such decisions led to the increase in the number of clients (which was positively viewed by the board as the organisation’s profits grew), but such actions were could (and did) lead to the decrease in liquidity and the fact that the bank was no longer solvent.

Major Issues

As has been mentioned above, the major issues existing in the organisation are associated with risk management and evaluation of the overall situation in the financial market:

Acceptance of risky practices

  1. Focus on profits.
  2. Inability to ensure the bank’s liquidity (Arsalidou 2015).
  3. Inability to comply with the regulations existing in the industry as well as the organisation (Collier & Agyei-Ampomah 2008).
  4. Inability to communicate the appropriate message in the time of crisis (Hart 2014).

The underlying reasons linked to the issues mentioned above are the lack of experience and adherence to risky decisions that are common in the business world but should be met with caution in the financial sphere. It is necessary to focus on short-term loans and mortgages has made the company one of the leading banks in the UK (Tricker 2012). This success can be regarded as one of the reasons why the board did not want to change the practices and adhere to the conventional strategy, which was formally accepted in the organisation (Chiu 2015).

The stakeholders did not mind the bank’s practices. The board of executives could be satisfied with the profits, the board of INEDs were also focused on profits and did not pay much attention to risks (which are to be considered meticulously in the financial sphere), the clients were also positive about the bank as they felt secure while receiving the services they needed. Therefore, the major issue was the focus on profits rather than risk management and the development of trustful relationships with clients.

Alternatives

Alternative A

One of the possible ways to address the problem was hiring more experienced INEDs, especially when it came to senior INEDs. The members of the board should have extensive experience in the financial sphere (Giles 2012). Savvy INEDs can evaluate the situation in the financial market and respond to challenges effectively. They can also assess the efficiency of this or that practice and strategy.

The decision to hire experienced INEDs could be beneficial for the organisation’s reputation, which would soon translate into increasing clients’ trust and growing profits. Experienced financial experts would change the risky ways employed in the bank and would make sure that mortgage financing relies fully on savers’ money. Some other services could be financed through loans from other banks or financial facilities (Young & Coleman 2010). This would save the bank’s funds and reputation.

Alternative B

Another alternative is the use of stricter regulations. The organisation could develop a particular corporate culture where the focus could be made on responsibility and security. The regulations had to include specific guidelines on the practices to utilise as well as sanctions in case the requirements were not met. The existence of such strict rules (and sanctions for non-compliance) would encourage employees to use conventional practices characterised by the focus on security.

The use of such guidelines would change the corporate culture, which would enable the organisation to avoid the crisis. The bank would be still solvent as its liquidity could be secured. The reputation of the bank would also be improved as the clients could see that the money was safe. At the same time, it is necessary to note that the board’s members, as well as executives of the bank, were unlikely to develop such strict regulations as they did not find conventional strategies necessary.

Alternative C

There could be another alternative, and it is associated with the use of similar practices based on the focus on profits rather than security. To make sure that the bank was solvent, the board could make a decision to get investment from abroad (Chinese financial facilities could be possible partners). Therefore, the company would not face the urgent need to address the National Bank, and the disclosure could be avoided (at least, at that period).

They would continue providing innovative financial services and loans, which could lead to their winning a larger market share. Nonetheless, the crisis of 2008 was global, and the bank in questions would find it difficult to get the necessary funds as financial facilities across the globe (including China and other emerging markets) could not ensure their own validity. Hence, it is quite likely that Northern Rock would still have to disclose the fact that they were not solvent.

Recommendations

Alternative A seems the most appropriate solution to the problem. The risky behaviours of the organisations would change if the board could properly evaluate possible negative outcomes of failure to use conventional strategies. The new board would decrease the scope of services provided and the bulk of loans, which would have positive long-term effects. The bank could increase its validity.

The reputation of the bank would be improved, and the needs of its clients would be met. The bank would also preserve the market share as it would not lose its clients while the competitors using risky practices would have fewer customers. This is the most plausible solution as it is easier and more important to change the board rather than try to change their views on the use of appropriate strategy in the financial sector. Alternative C is the least effective as it still leads to significant financial and reputational losses.

Reference List

Arsalidou, D 2015, Rethinking corporate governance in financial institutions, Routledge, Oxon.

Chiu, IHY 2015, ‘Corporate governance and risk management in banks and financial institutions’, in IHY Chiu & M McKee (eds), The law on corporate governance in banks, Edward Elgar Publishing, Cheltenham, pp. 169-196.

Collier, PM & Agyei-Ampomah, S 2008, CIMA official learning system management accounting risk and control strategy: strategic level, Elsevier, Oxford.

Giles, S 2012, Managing fraud risk: a practical guide for directors and managers, John Wiley & Sons, Chichester.

Hart, RP 2014, Communication and language analysis in the corporate world, IGI Global, Hershey.

MacNeil, IG & O’Brien, J 2010, The future of financial regulation, Bloomsbury Publishing, Portland.

Tomasic, R 2011, ‘The failure of corporate governance and the limits of law: British banks and the global financial crisis’, in W Sun, J Stewart & D Pollard (eds), Corporate governance and the global financial crisis: international perspectives, Cambridge University Press, Cambridge, pp. 50-75.

Tricker, B 2012, Corporate governance: principles, policies and practices, OUP Oxford, Oxford.

Tully, S & Bussett, R 2010, Restoring confidence in the financial system: see-through-leverage – a powerful new tool for revealing and managing risk, Harriman House Limited, Hampshire.

Young, B & Coleman, R 2010, Operational risk assessment: the commercial imperative of a more forensic and transparent approach, John Wiley & Sons, Chichester.

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IvyPanda. "Northern Rock Bank's Corporate Governance." August 19, 2020. https://ivypanda.com/essays/northern-rock-banks-corporate-governance/.

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IvyPanda. 2020. "Northern Rock Bank's Corporate Governance." August 19, 2020. https://ivypanda.com/essays/northern-rock-banks-corporate-governance/.

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IvyPanda. (2020) 'Northern Rock Bank's Corporate Governance'. 19 August.

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