Risk appetite frameworks
How to spot the genuine article
Everyone these days seems to agree that risk appetite frameworks are good things – even if no-one can quite agree what a good one looks like.
The regulatory landscape for banking and insurance firms – be it speeches, working papers and draft or final regulation – is full of references to risk appetite, its benefits, uses, applications and case studies of failed firms whose weak risk appetite frameworks played a part in their downfall.
When firms are criticised for shortcomings in their risk governance and management, an appetite framework is commonly prescribed as a cure by regulators. And yet, there remains a surprising variety of opinion about what it actually means to establish and embed a proper risk appetite framework.
While the concepts and themes discussed in this paper will be of interest to all financial institutions, this paper is particularly focused on the banking sector. Our goals in this paper are five-fold:
- Summarise the arguments in favour of risk appetite frameworks.
- Highlight the emerging consensus on the core concepts of risk appetite between regulators and firms within the financial services industry.
- Illustrate what we think ‘good’ looks like for a risk appetite framework.
- Suggest ways to spot a ‘genuine’ risk appetite framework, by giving examples of the sorts of hardheaded questions we would expect regulators and Non-Executive Directors to be asking firms about their risk appetite frameworks.
- Suggest what risk appetite might look like in three to five years’ time, based on the trajectory of regulation and trends in the banking and insurance industries.