TraceRiskFunctional AreasCorporate Governance

Corporate Governance

Don’t Confuse a Control Risk Assessment with Enterprise Risk Assessment

Don’t Confuse a Control Risk Assessment with an Enterprise Risk Assessment

In managing the internal audit function, the institution’s Audit Committee is responsible for commissioning a Control (or “Auditor’s”) Risk Assessment, developing audit plans and the overseeing the execution of the audit program. A Control Risk Assessment documents the internal auditor’s or outsourced audit service provider’s understanding of the institution’s significant business activities and their associated risks. These assessments typically consider the risks inherent in a given business line, the mitigating control processes and the resulting aggregate risk exposure to the institution. The assessments should be updated annually by the auditors to reflect changes to the system of internal control or work processes and to incorporate new lines of business.

Conversely, an Enterprise Risk Assessment can be described as a risk-based approach to managing an enterprise, integrating concepts of internal control, the Sarbanes–Oxley Act and strategic planning (remember: Strategy Drives Risk). ERM addresses the needs of various stakeholders (i.e., risk owners, risk managers, C-Suite executives, Board members) who need to understand the broad spectrum of risks facing the institution to ensure they are appropriately managed. Put another way, enterprise risk management is accomplished in large part by performing an enterprise risk assessment.

With that groundwork paid, let’s take a look at the Control (or “Auditor’s”) Risk Assessment first. The Control Risk Assessment methodology performed by the auditor identifies all auditable areas, provides a narrative basis for the auditor’s (not management’s) determination of relative risks, and, is consistent from one auditable area to another. The Control Risk Assessment quantifies Credit Risk, Interest Rate Risk, Liquidity Risk, Operational Risk, Compliance Risk, Strategic Risk, Reputational Risk, BSA Risk and Fair Lending Risk (if applicable). Some specific functions and activities may be embedded within larger categories; for example, some information technology risks are addressed in the Operational Risk area while certain other IT risks can be found in the Compliance Risk area. The auditor’s Control Risk Assessment considers the potential that deficiencies in the system of internal control would expose the institution to potential loss and provides the auditor with data sufficient to develop the scope, coverage, timing, frequency and budget for the audits planned for the year.

When appropriate, the auditor should consider of the introduction of new products and departmental changes which factor into the audit plan. It should be noted that ratings of particular business activities or corporate functions may change with time and the auditor should revise the method for assessing risk accordingly. A properly drafted internal audit plan is based on the auditor’s Control Risk Assessment and typically includes an evaluation of key internal controls within each significant business activity. Ideally, the auditor’s only role should be to independently and objectively evaluate and report on the effectiveness of an institution’s risk management, control and governance processes for the purpose of audit plan development. The assessment should be periodically updated to reflect changes in the system of internal control, work processes, business activities or the business environment.

Conversely, the institution’s Enterprise Risk Assessment provides management with actionable outcomes that facilitate risk mitigation, controls development and process remediation and includes the methods and processes used to seize opportunities related to the achievement of institutional strategic objectives by assessing them in terms of likelihood and magnitude of impact, determining a response strategy and monitoring progress. By identifying and proactively addressing risks and opportunities, the institution protects and creates value for its shareholders, employees and customers.

Enterprise risk assessment frameworks describe an approach for identifying, analyzing, responding to and monitoring risks and opportunities within the internal and external environment facing the institution. Management selects a risk response strategy for specific risks identified and analyzed, which may include:

  • Avoidance: exiting the activities giving rise to risk
  • Harnessing: taking action to reduce the likelihood or impact related to the risk
  • Alternative Actions: deciding and considering other feasible steps to minimize risks
  • Transferring: or sharing a portion of the risk
  • Accept: no action is taken due to a cost/benefit decision

Monitoring is typically performed by management as part of its internal control activities, such as review of analytical reports or conducting management committee meetings with relevant experts to understand how the risk response strategy is working and whether the objectives are being achieved.

So, you can see that each of these two risk assessment approaches have distinct objectives, methodologies and outcomes and therefore, should not be combined or mistaken for one another. Moreover, your regulatory examiners expect to see both approaches in operation at your shop. The bad news is that employing both approaches can be costly and time consuming. The good news is that there is a simple, cost-effective way to get them both done and achieve remarkable results that will impress your examiners and Board of Directors and keep your bank compliant with risk management mandates set forth by the OCC, FDIC and FRB.

If you’d like to know more or get some help with either one of these risk assessments. Visit www.tracerisk.com


How do I Implement ERM?

What does ERM do, actually?

  1. Defines and assigns Risk Values (i.e., Inherent Risk, Threats, Vulnerabilities, Annual Rates of Occurrence, Annual Loss Expectancy, Risk Appetite, Risk Tolerance, and Audit Frequency) for every Subject to be assessed.
  2. Provides ‘use cases’ that give context to the Subjects to be assessed by risk owners and managers.
  3. Provides Key Risk Indicators (KRIs) which will be rated for Probability and Impact.
  4. Sums up Probability and Impact ratings to reach Residual Risk outcomes and help determine audit frequencies.
  5. Provides “How We Reached Our Conclusion” for explaining current Residual Risk outcomes and offers links your own policies, procedures, forms, memos and other documentation that support Residual Risk outcomes.
  6. Provides an decision making custom reports specifically designed for risk owners and managers, senior management, the Board and your regulators.
  7. Provides a method for performing comprehensive “bottom up” risk assessments and for performing risk assessments on emerging products, services and activities before they are deployed.
  8. Provides flexibility when assigning risk owners and risk managers while maintaining full administrative control and oversight by the Chief Risk Officer.
  9. Includes supplementary policies, procedures, accessories, tools, resources, forms and immediate, one-touch access to relevant regulatory guidance (no need to ever leave the TraceRisk website to do regulatory research).

 

Who should perform the risk assessments?

Most banks today have assigned the responsibility for risk management to a Chief Risk Officer. Typically, he or she will be the “gatekeeper” for managing enterprise risk and overseeing the risk assessment process. But, it’s your bank’s risk owners and risk managers who actively participate in the risk assessment process and the TraceRisk implementer can help the Chief Risk Officer identify who they are.

What will the implementation process look like?

Ideally, assign a risk expert to assist your bank with implementing the solution of choice and maximizing all its capabilities and features. The implementer will be performing risk assessments with your staff and should also furnish the bank with a set of supplementary tools and resources including but not limited to:

  • ERM Policy, Procedures and Committee Charter (editable)
  • Checklist – Addressing Risk Management Shortfalls (for Board of Directors’ use)
  • Report Descriptions and Who Should Get Them (reporting TraceRisk outcomes)
  • “Chief Risk Officer’s Risk Management Report to the Board” template
  • Glossary & Definitions; Illustrations; Tips & Tricks when using TraceRisk

 

What does the Implementer do, exactly?

The Implementer assigned to your bank will ideally decades of enterprise risk management experience and be thoroughly familiar with all aspects of the your chosen solution. This individual will work closely with your risk owners and risk managers to accomplish the following:

  • Identify relevant business objectives before meetings or visitation commences.
  • Conduct an initial on-site meeting with senior management, risk managers and risk owners.
  • Identify the events or conditions that could affect the achievement of objectives.
  • Explain what Key Risk Indicators (KRIs) are and how they are used.
  • Assist risk owners and managers in assessing the likelihood and impact of risks across their assigned risk subjects. (This is the fun stuff)
  • Provide insight and tips on how to use the rich data sets captured on each of the 4 Dimensions of Risk: Subject, Silo, COSO & Risk Inventory. (More fun stuff)
  • Provide detailed guidance on how to succinctly and uniformly write conclusions on risk assessment outcomes (outcomes are called “Residual Risk”) and how to develop risk mitigation plans and techniques.
  • Demonstrate how to quickly produce meaningful reports for the Board, the regulators and Executive Management. The variations of the reports are entirely intended audience driven.
  • Train on use of the “New Product/Service – Risk Analysis”
  • Train on use of the “Risk Response” (for indicating how problematic conditions on higher risk Subjects will be handled).
  • Share Best Practices in all aspects of risk assessment and ERM program development.

When should you get started?

Now is the time to start performing your risk assessments. The FRB, OCC, FDIC and CFPB have issued plenty of guidance on risk management and they expect your bank to have your risk assessments done and ready for their field examiners to review.

Let’s get started so you can see what your bank’s risk profile looks like and get some risk mitigation in place before your next regulatory examination.

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Demystifying Risk Assessments

Some banks have an idea, albeit vague, about performing risk assessments. But few have made real progress in planning or actually implementing a Risk Assessment Program. Here is a practical approach that demystifies the process so you can get going!

History

Boards of directors have become increasingly aware of the need to manage the wider range of risks across the banking enterprise. They are looking for ways to meet their fiduciary responsibilities, manage their own personal liability and improve the business. They are asking about, and in some cases, are pushing strongly for a more coordinated and comprehensive process of managing risks − enterprise risk management (ERM), in other words.

At the heart of any ERM program is the risk assessment. And for some banks, the ability to perform a risk assessment poses a significant challenge.

Most bankers are already functioning at full capacity and adding to their workload will not be easy. Moreover, what exactly does ERM work look like? C-level officers are frequently at a loss on how to get started or how to make meaningful progress. They may question how risk assessments will enable them to more effectively manage compliance issues.

A “core risk assessment project” is a practical way to take advantage of what is currently being done in the bank and move forward while managing costs in a tight budgetary environment. The starting point is to identify the effectiveness of risk-related activities the bank has already put into place. Gaps can then be identified and prioritized, leading to significant progress on the journey to a more integrated, efficient and value-driven approach to risk management.

Regulator Expectations

Enterprise risk management has been discussed since before Y2K (remember that?), yet it has been rarely implemented effectively. Professional associations, internal audit groups, bank directors and chief risk officers have been hearing about ERM at conferences and seminars and there is no shortage of articles about ERM in trade publications. However, the discussion has remained largely academic and not actionable. In that light, the regulatory agencies have taken up ERM as a principal focus in their examination process and here’s how the OCC views the issue[1]:

“The OCC expects bank management and the board to oversee all new, expanded, or modified products and services through an effective risk management process. Failure to provide an effective risk management process is an unsafe and unsound banking practice. An effective risk management process includes: (1) performing adequate due diligence prior to introducing the product; (2) developing and implementing controls and processes to ensure risks are properly measured, monitored and controlled; and, (3) developing and implementing appropriate performance monitoring and review systems. The formality of the bank’s risk management process should reflect the size of the bank and the complexity of the product or service offered. Depending on these factors, it may be appropriate for the bank to establish an executive management committee to oversee development and implementation of bank products and services.”

While there is a genuine need for risk management, it is unreasonable to expect senior executives to fully understand the risks, and the interrelationships of the risks that their people are taking, without the use of improved tools and better methods.

Challenges

In many organizations, operational risks are being managed but frequently in haphazard and fragmented ways. Many banks lose sight of the big picture and do not sufficiently link risk management activities to their business strategies. Some risks are being identified and managed, but only with limited coordination. Other key risks are not even on the radar screen. Many activities are restricted to a controls-based approach with individual requirements being managed too narrowly. There is minimal or no coordination to take advantage of the value available in aggregating these risk management activities within an effective overall risk management approach.

The consequences of fragmented approaches can result in substantial reputational exposure and regulatory criticism. The challenge most community banks face is getting beyond the talking stage and understanding what needs to be done, and then getting on with it in a coordinated, uniform manner that does not require “reinventing the wheel” every year.

Let’s look at the benefits of a well established risk assessment program:

  • It establishes the inherent risk for each area under review
  • It establishes thresholds for risk appetite and risk tolerance
  • It establishes the Key Risk Indicators (KRIs) in a way that promotes a broader understanding of risks
  • It provides for measuring the probability of an adverse event or condition and the consequent impact
  • It provides a “residual” risk that establishes an overall risk profile for the bank
  • It puts in place a process to highlight the key risks, set an action plan, and then establish accountability for risk mitigation
  • It provides a consistent, uniform way of looking at risk at three different but connected levels: from a management perspective; from a Board perspective and from a bank examiner’s perspective
  • It enables organizational alignment to manage the risks and control the costs
  • It allows the bank to take on and effectively manage risks that its competitors cannot

Gaps

Risks to banks are categorized in operational, financial reporting and compliance areas – the three objectives of the integrated framework modified by the Committee of Sponsoring Organizations (COSO) in 2013. The illustration below looks complicated, but you needn’t fret about it. Just know that this universal framework has been designed to help foster an understanding of the dimensions of risk for those persons charged with risk program development. We’ll demystify all of this for you as you read further.

COSO’s visual model for ERM resembles a complex Rubik’s Cube®, and it is daunting to many bankers. In addition to the three risk objectives mentioned, there are five stages in the COSO ERM integrated framework representing what is needed to achieve each of the objectives (operational, reporting and compliance).

cosoReading from top to bottom, the five components start with “Control Environment” and conclude with “Monitoring Activities,” and there is a clear sequence of activities; some of the interim stages include “Risk Assessment” and “Risk Response.”

The remaining visible side of the cube outlines different levels of the organization. The categorization starts at the broadest level, the entity (or entire enterprise) and proceeds to a subsidiary level. This element of the model is designed to be tailored to each business line of the bank depending on organizational structure. Judging from the complexity of the COSO ERM model, the accompanying framework and separate risk assessment techniques, implementing ERM using this model as a starting point will not happen in most banks unless they have considerable resources and flawless project management skills.

So, What’s the Solution?

Enterprise risk management is a worthy goal for all banks, regardless of size. Risk management activities need to be tied to strategy and ultimately built into everyday business processes. The following project plan can enable banks to identify and coordinate activities they already have begun, identify risks not adequately managed, close gaps, and move forward. The steps of this plan are: 1) organizing your team; 2) establishing a framework; 3) assessing risks; 4) inventorying current risk-response activities; and, 5) closing the gaps.

 

Leveraging existing knowledge and programs will go a long way to helping reduce the effort in getting started. For example, internal audit, the compliance officer, the IT security officer and your risk officer (if you have one) have probably already conducted some type of risk assessment.

 

Here’s how to do it. . .

 

  • Organize the Effort: Bring resources together to coordinate your activities

 

To start on the right foot, it is important to assemble the right people and agree on timelines and objectives. Organizing requires assembling all the department heads and managers who have responsibilities for risk management activities to oversee the project and guide what will be done, when and by whom. The risk assessment processes need to be built with these stakeholders in mind and designed to suit the needs of the bank. Since the risk assessment is ultimately strategic in nature, it will never succeed without support from the Chief Executive Officer and other C-suite officers. It may be helpful to include the Chief Financial Officer, Chief Operating Officer, Internal Audit Director, Legal Counsel and, of course, the Chief Risk Officer, if you have one, into the process.

 

  • Establish a Framework Around Risk: Develop a model but keep it simple.

 

The risk assessment model should be comprehensive and useful, particularly for smaller banks where investment in risk assessment tools may have limitations. At TraceRisk, we have found that Software-as-aService (SaaS) offers the most cost-effective and readily implementable solution for performing the risk assessments. The approach to get started is one that works from a basic and logical model: Identify – Assess – Mitigate. “Identification” means knowing the key risks (KRIs); the “Assessment” stage involves scoring the probability and impact of events and conditions; and, the “Mitigation” phase means dealing with residual risks (mitigation).

 

A common understanding of some other key terms will be helpful so team members are on the same page when it comes to comprehending risk concepts, performing risk assess-ments and implementing risk management. Here are some of the most common terms:

  • Risk Appetite: The amount of risk that a bank is willing to seek or accept in the pursuit of its long term objectives.
  • Risk Tolerance: The boundaries of risk taking outside of which the bank is not prepared to venture in the pursuit of its long term objectives.
  • Risk Universe: The full range of risks which could impact, either positively or negatively, on the bank’s capabilities.
  • Risk Capacity: The amount and type of risk the bank is able to support in pursuit of its business objectives.
  • Risk Target: The optimal level of risk the bank wants to take in pursuit of a specific business goal.
  • Risk Limit: Thresholds to monitor that actual risk exposure does not deviate too much from the risk target and stays within the bank’s risk tolerance/risk appetite. Exceeding risk limits will typically trigger management action.
  • The Business Context: This includes understanding the state of development of the bank as a business, its size, industry sector, geographical spread and the complexity of the business model.
  • Risk Management Culture: This addresses the extent to which the board (and its relevant committees), management, staff and regulators understand and embrace the risk management systems and processes of the bank.
  • Risk Management Processes: This refers to the extent to which there are processes for identifying, assessing, responding to and reporting on risks and risk responses within the bank.
  • Risk Assessment: This refers to the bank’s identification of inherent risk, the probability of adverse events or conditions, the impact of such events or conditions, the resultant residual risk, an explanation of how risk conclusions were reached and what actions are planned or taken relative to the level of residual risk.
  • Risk Management Systems: This means the extent to which there are appropriate IT and other systems to support the risk management processes.
  • Risk Capacity: The resources, including financial, intangible and human, which a bank is able to deploy in managing risk.
  • Risk Management Maturity: The level of skills, knowledge and attitudes displayed by people in the bank, combined with the level of sophistication of risk management processes and systems in managing risk within the bank.
  • Risk Capability: A function of the risk capacity and risk management maturity which, when taken together, enable a bank to manage risk in the pursuit of its long term objectives.
  • Propensity to Take Risk: The extent to which people in the bank are predisposed to undertaking activities the impact, timing and likelihood of which are unknown, and which is influenced by financial, cultural, performance and ethical considerations.
  • Propensity to Exercise Control: The extent to which people in the bank are predisposed to take steps to change the likelihood, timing or impact of risks, influenced by financial, cultural, performance and ethical considerations.
  • Performing the Actual Risk Assessment: Avoid getting lost in the details. Start off by thinking broadly about risk and then become more detailed.

Most community banks are already doing a good deal of risk management, but the processes and reporting are often isolated, inconsistent and fragmented. Risks related to internal controls over UDAAP for example, are under scrutiny because of Dodd-Frank. ECOA risks are managed centrally in many banks while at others, it is de-centralized. In some banks, Fair Lending risks are never even measured at all! At this point it is important to ascertain how much your bank is already doing to manage risk. Your team will need to interview key people and ask questions in an open-ended way using Key Risk Indicators (KRIs) as guidance (the “Identification” phase).

Likely candidates to interview include the Compliance Officer, the BSA Officer, the Security Officer (physical and IT/Data) the Chief Credit Officer, heads of business units and your marketing officer. Use Key Risk Indicators to establish a dialogue that brings out the reality of compliance risk without suggesting what it should be.

Rather than thinking in narrow terms, start off by thinking about the largest risk your bank faces: not achieving its overall business objectives. These objectives emerge from the strategic direction set at the highest levels of the bank. Then, begin to identify what the top 10 risks at your bank could be and how they affect the bank’s overall strategic objectives. Confining your list to 10 key risks (or 5, or 15, depending on your bank) in this early stage will keep your team focused on the big picture rather than becoming mired in details.

Once you have corralled the top 10 risks, you can break them down by subject, regulation, department or any other criteria that suits your bank or approach so you can begin to assess the specific risks and get closer to the actual “residual risk” levels (the amount of risk left over after mitigation techniques have been applied). This is the “assessment” phase[2].

A good assessment tool will help you identify a universe of 25 to 40 risks per subject (i.e., products, services, functional areas) so you can learn where risks reside throughout the bank and you can assess their significance. Residual risks will not be the same for any two banks. For some banks, the significance of their geographic area poses higher risks than other financial institutions. In other cases, product risk will have higher risk implications. Still others may face bigger risks when it comes to pricing. It is up to the team to collaborate across the bank’s array of products and services to identify, understand and mitigate the residual risks.

Developing strong risk assessments will not require discontinuation of existing risk activities and starting from scratch. Instead, you can build on existing activities that have proven value and transfer the data into a risk assessment analysis model to achieve a more holistic outcome.

  • Identify Gaps and Prioritize: Compare your inventory of current risk responses to the top 10 priorities.

Now that you know the risks that can impede achievement of your bank’s business objectives, along with the risk response activities currently being conducted, you can study the residual risks. Which risks are being adequately managed? Which ones are missing from the radar screen? Where is an initiative already in place that help you to better understand and manage risks?

Once the residual risks by subject have been assessed, the next step is to develop an approach to close the gaps (this is the “mitigation” phase). This begins with prioritizing which gaps have the greatest potential to derail achievement of your bank’s business objectives. Which would require the greatest deployment of human or financial capital? Which ones would demand outside resources? Which ones could be accomplished in the shortest time?

Many elements of your bank’s existing structure may be sufficient and will be retained, but significant gaps will probably be found. These may be in risk management leadership, risk assessment methodology, specific technical skills, common processes or technological capabilities. Internal cultural biases or paradigms may need to be changed as well.

After weighing the urgency and the resources required, you then can develop specific strategies to close the most critical gaps. While keeping the desired end result in mind, each of the strategies can be slotted into an implementation plan, complete with action steps and a timeline. A process will need to be established for ongoing reporting of the progress to mitigate the risks, as well as periodic reassessment of the risks being tracked.

Discuss ways to move forward with members of your team and let members of this group direct you to the appropriate people for answers. Also, be alert for new risks, whether arising from the environment, regulatory changes, competitors or new products. You’ll need to include recommendations to guide the bank to improve ongoing risk assessment processes. Decisions will need to be made on how to best manage a risk and where it should be managed. Will you centralize certain activities, or embed them in specific processes or business units?

Conclusion

Assessing risk is a journey. A well-defined and supported risk assessment project enables the bank to “jump start” the process, rather than delaying moving forward because the concept seems grandiose, costly and unworkable. In fact, delaying further on assessing enterprise risk can very likely lead to regulatory action in the form of a “Matter Requiring Attention” or worse, compelling your bank to develop and implement a risk assessment program within a timeframe set by the regulators. Nobody wants that.

It’s best to take stock of existing risk assessments as well as risk-response activities and build on them right now. At the end of the project, your executive management group, the Board of Directors and your risk assessment team will realize the value of implementing the risk assessment model and continuing the risk management journey.

To learn more or to see how the TraceRisk solution can save you tons of time and dollars, call Derek Yankoff, Chief Design Officer at (877) 711-4824

or email him at derek.yankoff@tracerisk.com

Copyright ©2016 TraceRisk llc All Rights Reserved. TraceRisk and the TraceRisk logo are trademarks of MSBMCo, Inc. in the U.S. and/or other countries. All other trademarks are the property of their respective owners.

[1] OCC Bulletin 2004-20

[2] TraceRisk has this approach built right in on over 75 Subjects and 3000 KRIs.


Corporate Governance & Ethics

Use Case for Assessing Corporate Governance & Ethics Risk
Why assess the risk? Given the important financial intermediation role of banks in the economy, the public and the market have a high degree of sensitivity to any difficulties potentially arising from any corporate governance shortcomings in banks. Poor corporate governance can contribute to a bank’s failure and can lead to markets losing confidence in the ability of the bank to properly manage its assets and liabilities, including deposits, which could in turn trigger a bank run or a liquidity crisis. In addition to its responsibilities to shareholders, the bank also has a responsibility to its depositors and to other recognized stakeholders. The presence of an effective corporate governance system helps to provide a degree of confidence that is necessary for the proper functioning of a community bank.

Who should assess the risks? Board Chairperson, Board Members, Chief Executive Officer / President, Legal Counsel
How to assess the risk: Rate the KRIs to determine if a threat would successfully exploit a vulnerability and to justify expenditures to implement countermeasures to protect the bank’s assets or reputation.
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Management Succession Risk

Use Case Management Succession Risk

Succession planning is a means for a bank to ensure its continued effective performance through leadership continuity. For a bank to plan for the replacement of key leaders, potential leaders must first be identified and
prepared to take on those roles. It is not enough to select people in the bank who seem “right” for the job. Not only should the experience and duties be considered, but also the personality, the leadership skills and the readiness for taking on a key leadership role.

Next, determine which people to consider for the leadership positions. It is best to identify this group with an objective system instead of just selecting “favorites.” One option is for people to self-select into the process. This way, those who are already interested in the leadership roles will volunteer. They may be the most likely to take it seriously. Several “hopefuls” should be identified for each position to be filled. This allows the potential leaders to be “groomed,” trained, and mentored for the possibility of filling the leadership positions. When the time comes for the position to be filled, there will be several people from which to choose, all of whom have had the time to develop for the new role. At least one of them may be ready to meet the requirements.

In order to prepare potential leaders, the gap between what they are ready for now and what preparation they need to be ready for the job when it is available needs to be determined. This information can help determine what
training, experience, and mentoring is needed. By considering their past performance as a volunteer, past experience, fit with the bank culture, and other staff members’ acceptance of them as a potential leader, the best fit can be determined. Also, ensure that the potential leaders are willing to carry out the bank’s mission and to continue the bank’s philosophy and culture.

Once the potential leaders have been identified, a plan for each of them should be developed. Each potential leader should be assigned a mentor; this mentor should be the person whom they may replace. The mentor and the potential leader should form a teacher-student relationship. When issues arise that need problem solving or decision making, the leader should meet with the potential leader to ask how he or she would handle the situation.

Allow the potential leaders time to “shadow” the leaders. If possible, allow them to attend board meetings and participate in the decision making. This is a great way to see how they problem solve and interact. The leaders may
even want to present the potential leaders with a problem and allow them to solve it as a group without any benefit of the leaders’ input. See if the potential leaders would react in a way that is suitable or favorable.

Also allow them to participate in goal-setting activities, such as strategic planning or budgeting. It is important to see them in action. This process should not be a means for the leaders to choose the person most like them. Because a potential leader solves problems the same way as the leader does not make him or her the best candidate.

The board may want to plan to conduct interviews with each candidate, assessing his or her abilities to make decisions, solve problems, behave appropriately in sensitive situations and lead those who will report to him or her. If appropriate, it is a good idea to allow direct reports to have some say in who will lead them.

Who Should Assess the Risk? Board of Directors, CEO, Executive Committee