• Industry: Financial Services
  • Type: Regulatory update
  • Date: 11/22/2013

Developing a strong risk appetite program 

Creating a robust risk management program, and integrating it with broader corporate strategy, is a critical challenge for banks. An explicit and effective risk appetite statement is an increasingly important element of this process.

The ICAAP process – the internal capital adequacy assessment mandated by the Basel Accords – has been familiar for some years, and an explicit determination of risk appetite is one of the key foundations for this. However, with the aim of improving risk management in the wake of the crisis, regulators in most jurisdictions are placing much greater emphasis on this issue, and supervisory bodies are scrutinizing banks’ responses much more closely.1 Common reference publications include: Financial Stability Board’s (FSB) “consultative document” on Principles for an Effective Risk Appetite Framework, Basel Pillar 2 ICAAP and Pillar 3 Disclosures, Senior Supervisors Group’s 2010 report on developments in risk appetite frameworks and IT infrastructure, The Institute of International Finance’s (IIF) recommendations and best practices for determining a bank’s risk appetite, etc.

In its July 2009 publication titled “Enhancements to the Basel II framework,” the Basel Committee on Banking Supervision stated “it is the responsibility of the board of directors and senior management to define the institution’s risk appetite and to ensure that the bank’s risk management framework includes detailed policies that set specific firm-wide prudential limits on the bank’s activities which are consistent with its risk taking appetite and capacity.”2 Enhancements to the Basel II framework, Basel Committee on Banking Supervision, July 2009, available (PDF 188 KB) as of August 16, 2013.

In some jurisdictions, the scope of relevant risk extends beyond financial elements to embrace areas such as brand, reputation, tax planning stance, culture and behavior. In addition, external stakeholders increasingly expect banks to formally document their risk objectives, integrate risk management with wider strategy and clarify the intersection between risk-taking and risk-mitigating objectives.

Against this background, boards and bank executive teams need to look afresh at their risk appetite program to ensure it supports broad bank growth and business strategies.

This paper (PDF 832 KB) describes several challenges associated with risk appetite program development, technical constraints associated with implementation and some commonly deployed solutions.

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