Robert Bruce

There is an assumption within the corporate governance world that independence is absolutely paramount. But there is growing evidence, in the wreckage of the banking crisis, that this may not always work the way regulators fondly believe.

Take the report from the Treasury Select Committee on reforming corporate governance as a result of the banking crisis. As the hearings with bank auditors and City regulators unfolded, a very different picture emerged. And much of that was down to an over-reliance on the concept of independence. Effectively, the hearings revealed that, since the inception of the Financial Services Authority, independence has gotten in the way of an informed understanding of what was happening within the banks and where risks might be arising. The useful exchange of confidential information which would have informed any views about problems brewing ahead had been forced to come to an end: that sort of thing isnít independent, you see.

As the report said: 'The FSA has the power under section 166 of the Financial Services and Markets Act 2000 (FSMA) to request from banks' auditors reports on areas such as financial information, fraud, internal controls or compliance with particular regulations. However, the ICAEW said that these powers were used 'infrequently' and that the current regime contrasted with that which operated under the Bank of England's supervision of banks, in which auditors were 'routinely requested' to conduct such work.'

Indeed, usefulness has been squeezed out of the system by the regulatory process. The reportís final conclusions underline this. 'The FSA's piecemeal approach to garnering auditor knowledge about individual banks indicates to us a wasted opportunity to improve the effectiveness of bank supervision,' the report said. 'In future, the FSA should make far more use of audit knowledge on a confidential basis.'

This, in fact, harks back to the days when much of the real work in re gulation went on behind closed doors, to the days when amid a bank rescue, the chairman of one of the biggest banks could be ushered out of the back door of the Bank of England late on a Friday night with a coat over his head. But that was back in the mid-1970s.

These days, the concept of independence is even more prized than the concept of effectiveness.

We are also now in the midst of the process of looking again at the Combined Code, that sacred document enshrining the principles and concepts of UK corporate governance. This has proved itself to be a highly effective system, but it is not possible in the current climate to say that something is just fine. Revisions must be made, and to be fair, some reforms in the system should be made. But the danger is that the ideas which are useful will be discarded in favour of those which, to the outside world, look rather more draconian.

The comments are now all safe and secure at the Financial Reporting Council and a report will duly appear later this year. But perhaps one area which could be usefully looked at is who is likely to be more effective, in the light of the disasters in the banking world over the last few years, at spotting that the culture of an organisation is changing and that problems are starting to appear on its horizon.

You would hope that it would be the board of directors, prompted perhaps by the finance director, which would be the prime group to carry out this role. But the tales of board meetings such as those at Northern Rock or Royal Bank of Scotland, with bullying chief executives hectoring a hapless board whenever risks or some potential difficulty was being pointed out, rather put the lid on any such hopes.

Then there are the non-executive directors. Here again, much hope had been put in that quarter, particularly with regard to spotting growing risks. But the crisis has disappointed those who believed audit committees were a panacea. True, audit committees have proved incredibly useful and in the vast majority of cases, really raised the corporate governance game. But within the banks they have had difficulties. The organisations within a global banking monster proved so disparate, disconnected and in many cases simply made up of liars hiding the evidence, that audit committees were no match.

External auditors are now so heavily set about with regulatory shackles that they find it extraordinarily difficult to fulfil the simple advisory and warning roles that come naturally to them.

Instead, it seems that corporates have to look elsewhere. If there is one lesson learned in all this, it's that it is not processes or systems that bring an organisation to its knees. It is the culture turning rotten that does it. And to spot that, you need insiders. Step forward the internal auditors. Directors need to enhance the internal audit function and use it effectively as the corporate eyes and ears.

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