Risk appetite in the financial services industry
A requisite for risk management today
Close evaluation of the origins of the turmoil of the last several years has underscored the critical importance of effectively managing risk. As a result, it may come as no surprise that regulators have set new expectations for risk management and, specifically, risk appetite frameworks, including the content of the risk appetite statement and the level of rigor with which it is communicated and monitored across firms.
It has also reinforced the benefits that a properly articulated statement of risk appetite and related framework can provide:
- A clear articulation of the business activities a firm is willing to engage in and the levels of risk it is willing to assume
- An understanding of all material risks taken by the firm, both at the business unit level and in aggregate
- A foundation for communication among internal and external stakeholders, as use of firm-specific language promotes shared understanding of terminology and enhances risk culture
- A framework for formulating strategic and tactical business decisions
- A means to engage the board of directors in improving risk governance and discussion of risk from a strategic point of view
- Ability to measure, monitor and adjust, as necessary, the actual risk positions against expressed risk appetite and facilitate communication to key stakeholders
Today, the importance of implementing a board-approved risk appetite and framework is clear — in addition to being a direct link to the formulation of corporate strategy, it is also a key element of effective risk management, governance, and risk culture. For the purpose of context setting, this paper provides a brief recap of the evolution of the risk appetite concept in the banking industry. Our main focus, however, is the practical application of the risk appetite framework to help board members and senior business and risk executives drive the implementation of such a framework at their institutions.