The responsibility of management board and supervisory board members of a cooperative bank does not end with the formal adoption of policies and procedures. We explain how the Polish Financial Supervision Authority (KNF) assesses the actual functioning of internal governance, the quality of management information, the effectiveness of controls and the activity of the bank’s governing bodies in light of Recommendation Z and supervisory practice.

Cooperative banks are an important part of Poland’s financial sector. They operate close to local communities and often combine ownership and customer relationships. Their business model therefore relies to a particularly significant extent on trust, transparency and the quality of governance.

The cooperative banking sector currently operates in an environment of increasing regulatory, economic and organisational requirements. This heightens the importance of effective internal governance and the genuine accountability of the bank’s governing bodies. Institutional protection schemes are an important part of this environment, as participation in such schemes provides cooperative banks with an additional layer of monitoring, control and audit.

From the perspective of the management board and the supervisory board, this means that the performance of their duties is assessed not only against applicable law, Recommendation Z and the KNF’s supervisory practice, but also through the control mechanisms operating within the institutional protection scheme.

The issue of the responsibility of management board and supervisory board members of a cooperative bank is particularly significant in the context of Recommendation Z issued by the Polish Financial Supervision Authority and supervisory expectations concerning internal governance, risk management, internal control and the quality of management information.

Recommendation Z — key assumptions and relevance to cooperative banks

Recommendation Z was issued under Resolution No. 289/2020 of the Polish Financial Supervision Authority of 9 October 2020, pursuant to Article 137(1)(5) of the Banking Law. This provision authorises the KNF to issue recommendations concerning good practices for prudent and stable bank management. The KNF expected banks to implement Recommendation Z by 1 January 2022.

Recommendation Z constitutes a set of good practices concerning internal governance in banks. It covers, in particular, the bank’s management system and organisational structure, operating principles, powers, duties and responsibilities, as well as the relationships between the supervisory board, the management board and persons performing key functions.

The principle of proportionality provided for in Recommendation Z is particularly important for cooperative banks. It allows the manner in which the requirements are implemented to be adapted to the scale, nature and complexity of the bank’s activities, including its operation within an institutional protection scheme.

Proportionality does not, however, reduce the responsibility of the bank’s governing bodies. The management board remains responsible for designing, implementing and ensuring the effective operation of the internal governance framework, while the supervisory board remains responsible for assessing and overseeing that framework.

In other words, certain processes or control support functions may be carried out using system-level arrangements, but responsibility for the quality of supervision, decision-making and management information cannot effectively be outsourced.

Allocation of roles between the management board and the supervisory board

The owners of a cooperative bank are its members, who are often also its customers. Delegates are elected from among the members to participate in the general meeting or the meeting of representatives, which is the bank’s highest decision-making body. During such meetings, the supervisory board is appointed to represent the interests of the cooperative’s members and oversee the bank’s activities.

Acting pursuant to applicable law and the cooperative bank’s articles of association, the supervisory board oversees the bank’s operations, including the functioning of the internal governance framework. Its powers also include appointing the president of the management board.

The management board, in turn, is responsible for the day-to-day management of the bank and for ensuring that internal governance principles are implemented and applied effectively in operational practice.

Recommendation Z emphasises the need for a clear separation of management and supervisory functions and for responsibility to be assigned to the statutory governing bodies.

The management board is responsible for designing, implementing and ensuring the effective operation of the internal governance framework, including the risk management system, the internal control system and compliance with applicable law and supervisory regulations.

The supervisory board is responsible for assessing the adequacy and effectiveness of these arrangements and for continuously monitoring how they operate.

The responsibilities of the two governing bodies are complementary. The management board manages, organises and implements arrangements, while the supervisory board assesses, oversees and enforces remedial measures where the information presented or the bank’s performance indicates irregularities or an elevated level of risk.

Practical application of Recommendation Z

In practice, the application of the principles set out in Recommendation Z is not limited to the formal adoption of rules of procedure, policies and procedures.

The management board is responsible for their effective implementation, in particular by establishing risk management procedures, organising the internal control system, ensuring adequate human resources and continuously monitoring key risk indicators.

This includes, among other matters, active management of the credit portfolio, responding to deterioration in asset quality, ensuring capital adequacy and maintaining compliance with the requirements of the regulator and the affiliating bank.

The supervisory board performs its duties by periodically reviewing reports submitted by the management board, assessing the effectiveness of the risk management and internal control systems, monitoring implementation of the bank’s strategy and analysing its financial performance.

An active approach by supervisory board members is particularly important. This includes asking questions, challenging assumptions, requesting explanations and enforcing remedial measures where irregularities are identified.

As a result, the actual responsibility of the bank’s governing bodies is reflected not merely in the existence of procedures, but in the quality of decisions made, the level of control exercised over risks and the ability to ensure the bank’s stable and secure operation.

KNF supervisory practice — how compliance with Recommendation Z is assessed

In the KNF’s supervisory practice, the assessment of compliance with Recommendation Z is not limited to formally verifying whether the bank has adopted the required internal regulations.

The supervisory authority analyses how the arrangements set out in the articles of association, rules of procedure, policies and procedures function in practice. This assessment is based, among other things, on the Supervisory Review and Evaluation Process, known in Poland as BION, inspection activities, supervisory and post-inspection communications, an analysis of materials submitted by the bank and an assessment of how the bank’s statutory governing bodies operate.

The KNF expects the management board not only to design and implement the internal governance, risk management and internal control systems, but also to ensure their actual effectiveness.

The supervisory board, in turn, is expected to exercise active, documented and competent oversight of the management board’s activities. This includes analysing reports, assessing the quality of management information, enforcing remedial actions and verifying whether the bank genuinely manages risk in a manner proportionate to the scale and profile of its activities.

The Management Information System as a tool supporting the accountability of governing bodies

The conclusions arising from the practical application of Recommendation Z are closely linked to the operation of the Management Information System.

It is a key tool supporting both the management board and the supervisory board in performing their duties. The effectiveness of management and supervision depends to a significant extent on the quality, completeness and timeliness of management information, including in particular data concerning risk, financial performance, capital adequacy and the operation of the internal control system.

The management board uses the Management Information System to monitor the bank’s activities on an ongoing basis, make operational decisions and identify potential threats.

The supervisory board bases its oversight and assessment activities on reports generated within the Management Information System, enabling it to verify the effectiveness of the management board’s actions and the adequacy of the risk management and internal governance systems.

Deficiencies in the Management Information System may limit the ability of the bank’s governing bodies to perform their functions properly.

Where the supervisory board receives incomplete, inconsistent or delayed information, its actual ability to exercise oversight is restricted. Where the management board does not have access to reliable management information, the risk of decisions being made on the basis of an incomplete view of the bank’s position increases.

Responsibility of management board and supervisory board members

The assignment of specific duties to members of the management board and the supervisory board is not merely organisational in nature.

In the KNF’s supervisory practice, the improper performance of duties by the bank’s governing bodies may result in specific consequences for persons performing management and supervisory functions.

The Banking Law gives the KNF a range of supervisory measures that may be applied where irregularities are identified in a bank’s operations. These include the power to issue recommendations, require the preparation and implementation of a recovery programme and apply personal supervisory measures to members of the bank’s governing bodies.

In certain circumstances, the KNF may also influence the appointment and continued performance of management functions, including through the assessment of the suitability of members of the bank’s governing bodies.

An important element of modern supervision is the suitability assessment, commonly referred to as the fit-and-proper assessment.

The assessment covers not only professional qualifications and experience, but also reputation, the ability to provide assurance of prudent and stable management of the bank, and the capacity to devote sufficient time to performing the relevant function.

A negative suitability assessment may require the bank to implement remedial measures and, in extreme cases, may result in the individual being unable to continue performing the function.

Responsibility relating to financial reporting is particularly important from the perspective of members of the management board and the supervisory board.

Under Article 4a of the Polish Accounting Act, the entity’s management and the members of the supervisory board or another supervisory body are required to ensure that the financial statements and other reports specified in the Act comply with the applicable statutory requirements.

They are jointly and severally liable to the entity for damage caused by an act or omission constituting a breach of this obligation.

This aspect of responsibility is particularly important from an audit perspective. The role of the supervisory board cannot be limited to passively accepting information presented by the management board.

Supervisory board members should actively analyse the financial statements, assess the effectiveness of the internal control system and review the financial reporting process.

The management board, in turn, should ensure the operation of processes that guarantee the completeness, reliability and timeliness of data used both in financial reporting and in the Management Information System.

Link to CRR prudential requirements

The principles set out in Recommendation Z are closely linked to the requirements arising from the Capital Requirements Regulation, or CRR, which establishes uniform prudential requirements for credit institutions across the European Union.

The CRR focuses primarily on quantitative matters such as capital adequacy, liquidity and the mitigation of credit, market and operational risks.

Recommendation Z supplements these regulations with qualitative elements, including the internal governance framework, control mechanisms, risk management culture and rules governing the operation of the bank’s governing bodies.

In practice, this means that effective compliance with prudential requirements depends on the proper functioning of management and supervisory structures.

The responsibility of the management board for ensuring compliance with prudential regulations, together with the role of the supervisory board in monitoring that process, forms a key part of a coherent bank management framework.

Summary: proportionality does not remove responsibility

Recommendation Z allows cooperative banks to apply the principle of proportionality, while participation in an institutional protection scheme may support the bank in performing selected control, audit and monitoring functions.

This does not, however, change the fundamental principle that responsibility for internal governance, the quality of management information, the effectiveness of supervision and the reliability of financial reporting remains with the bank’s governing bodies.

For management board members, this means ensuring that management, control and reporting systems operate effectively in practice.

For supervisory board members, it means exercising active, competent and documented oversight of the management board’s activities.

For both governing bodies, it means recognising that deficiencies in internal governance may have not only organisational consequences, but also supervisory, legal and financial implications.

In practice, the relevant question is therefore not whether the bank has adopted the regulations required by Recommendation Z, but whether the bank’s governing bodies can demonstrate that those regulations operate effectively, are proportionate to the scale of the bank’s activities and are genuinely used in the decision-making process.

How can PKF help?

PKF supports cooperative banks in the practical assessment and strengthening of their internal governance frameworks.

Our support may include, in particular, reviewing the compliance of organisational arrangements with Recommendation Z, assessing the effectiveness of the Management Information System, analysing the flow of information between the management board and the supervisory board, reviewing internal control mechanisms and conducting workshops for management board and supervisory board members on accountability, documenting oversight activities and the KNF’s expectations.

A properly designed review makes it possible to identify gaps before they become the subject of supervisory correspondence, an inspection or a dispute concerning responsibility.

This is particularly important for cooperative banks, where the principle of proportionality should support practical and effective arrangements but must not result in the dilution of the responsibility of the bank’s governing bodies.

Article by PKF expert Dorota Romek, Audit Manager in PKF’s Financial Institutions Department.