Table Of ContentRisk Appetite
Framework
Challenges
Tsuyoshi Oyama
Deloitte Touche Tohmatsu
Global Association of Risk Professionals
December 2013
This paper does not include the official view of Deloitte Touche Tohmatsu
LLC but only reflects the lecturer’s own opinion.
What is risk appetite?
Risk appetite
“Level and type of risk a firm is able and willing to assume in its exposures and business activities,
given its business objectives and obligations to stakeholders”
Senior Supervisors Group, “Observation on Development in Risk Appetite Frameworks and IT
infrastructure, 2010
⇒ Risks that the firm, or the management, decides to take in order to meet business objectives
⇒ Significant difference from the conventional risk management is that “the management” is the
subject and “to meet business objectives” is the object
Risk capacity
“The maximum level of risk the firm can assume before it breaches regulatory constraints (e.g.,
capital, liquidity) or other stakeholders’ constraints (e.g., dividend pay-out)”
Financial Stability Board, “Thematic Review on Risk Governance – Peer Review Report” 2013
Approved risk appetite, risk limit
“Risk level that when actually breached will require immediate remedial action”
Financial Stability Board, “Thematic Review on Risk Governance – Peer Review Report” 2013
2 | © 2012 Global Association of Risk Professionals. All rights reserved.
Pulling factors of risk appetite
Risk limits that major stakeholders expect financial institutions to keep ⇒ risk capacity
From a viewpoint of...
• Regulators ─ Stability of financial system, mitigation of moral hazard
• Rating agencies ─ Preventing abuse of asymmetric information regarding creditworthiness
• Bond holders ─ Concerns over risk transfer from stakeholders
• Public ─ Concerns over risk of damaging social justice
• Stakeholders ─ Concerns over risk transfer from the management
A situation which the management “do not want to see,” or in other words, a situation where they would
be held responsible is usually situated one step behind the level of risk capacity ⇒ (pulled) risk appetite
Specifically:
• CAR/Solvency ratio falls below a certain level
• Liquidity ratio falls below a certain level
• Revenue falls below a certain level
• Economic capital reaches more than a certain proportion of CAR
• Credit rating falls below a certain level
• Risk premium goes above a certain level
• Rise in reputation risk, etc.
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Pushing factors of risk appetite
Risk level that major stakeholders expect financial institutions to take ⇒ （pushed） risk appetite
From a viewpoint of…
• Stakeholders ─ Expectation on return
• Public ─ Positive effects on the economy and maintaining social justice
• Regulators ─ Realization of sound financial intermediation, contribution to enhancing profitability of
financial institutions that strengthens their mid- and long-term sustainability
• Rating agencies/bond holders ─ Contribution to earning power that strengthens mid- and long-term
sustainability
Specifically:
• Returns based on ROE exceed a certain level
• Securing more than a certain level of risk-based return
• Securing dividends over a certain level
• Expansion of loans in general
• Expansion of loans to certain sectors, etc.
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Relationship between risk appetite, risk capacity and risk profile
Regulator/
deposit holders
Rating agency
Risk capacity
Bond holders
Pulling force
Board/senior
Risk appetite
manager
General public
Pushing force
Risk profile
Shareholders
Employees
Minimization Optimization
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Hierarchy of risk appetite
Risk capacity indicators Strategic level Tactical level Operational level
CAR
Liquidity ratios Risk capacity
Credit rating
…
Risk appetite indicators
CAR Risk appetite Risk limit Risk limit
Liquidity ratios
Income/ROE
… Risk profile Risk profile Risk profile
6 | © 2012 Global Association of Risk Professionals. All rights reserved.
Rising supervisory interest in risk appetite framework (RAF)
“Observations on Developments in Risk Appetite Frameworks and IT Infrastructure”
Senior Supervisors Group (2010)
− RAF should contribute to the following:
• Development of organization’s risk philosophy
• Strategic decision making tool
• Forward looking view of a firm’s desired risk profile
• Flexible and responsive reaction to environmental changes
• Preparation for the unexpected
“Core principles for effective banking supervision” BCBS (2012)
− Emphasis on the importance of establishing a risk management process that takes risk
appetite for credit, market and operational risks into consideration
7 | © 2012 Global Association of Risk Professionals. All rights reserved.
Rising supervisory interest in risk appetite framework (RAF)
“Increasing the Intensity and Effectiveness of SIFI Supervision” FSB (2012)
− Risk appetite has become a common topic among the management but needs to be translated
down into the firm’s culture (compensation, etc.)
− Example – Factors for effective risk appetite statement (RAS):
• Strong linkage with the corporate strategy, capital and budget
• Set the tone for desired operational behaviors (e.g., linked to performance review and
compensation)
• Include qualitative statements
“Thematic Review on Risk Governance” FSB (2013)
− Supervisors of major economies are focusing on the following:
• Integration of strategic, financial and capital planning process and compensation practices
into RAF
• RAF takes account of all risks (financial and non-financial)
• Whether robust procedures and controls are in place for the setting and monitoring of the
agreed risk appetite
• Translation of risk appetite into limits and triggers by risk type
8 | © 2012 Global Association of Risk Professionals. All rights reserved.
Rising supervisory interest in risk appetite framework (RAF)
“Principles for An Effective Risk Appetite Framework” FSB (2013)
− An effective RAF should:
• Establish a process for communicating the RAF across and within the firm and, to some extent, to
external stakeholders;
• Be driven by both top down board leadership and bottom up involvement of management at all
levels, and embedded and understood across the firm;
• Facilitate embedding risk appetite into the firm’s risk culture;
• Act as a brake against excessive risk-taking;
• Allow for the risk appetite statement to be used as a tool to promote robust discussions of risk and
as a basis upon which the board, risk management and internal audit functions can effectively and
credibly debate and challenge management recommendations and decisions;
• Be adaptable to changing business and market conditions so that, subject to approval by senior
management and the board as appropriate, opportunities that require and increase in the risk limit
of a business line or legal entity may be counterbalanced by a reduction in the risk appetite
allotment of another business line or legal entity, or by an allocation of an excess in risk limit, in
order for the firm to remain within the agreed firm-wide risk appetite; and
• Be consistent with the principles in this document
9 | © 2012 Global Association of Risk Professionals. All rights reserved.
Rising supervisory interest in risk appetite framework (RAF)
“Principles for An Effective Risk Appetite Framework” FSB (2013)
− An effective RAS should:
• Be linked to the firm’s short and long term strategic, capital and financial plans, as well as
compensation programs;
• Establish the amount of risk the firm is prepared to accept in pursuit of its strategic objectives and
business plan, taking into account the interests of its customers (e.g., depositors, policyholders)
and shareholders as well as capital and other regulatory requirements;
• Determine for each material risk the maximum level of risk that the firm is willing to operate within,
based on its risk appetite, risk capacity, and risk profile;
• Include quantitative measures that can be translated into risk limits applicable to business lines,
legal entities and groups, which in turn can be aggregated and disaggregated to enable
measurement of the risk profile against risk appetite and risk capacity;
• Include qualitative statements for risks that are not easy to measure, including reputational and
financial consequences of poor management of conduct risks across retail and wholesale markets,
and establish some form of boundaries or indicators to enable monitoring of these risks;
• Ensure that the strategy and risk limits of each business line and legal entity align with the firm-
wide risk appetite statement as appropriate; and
• Be forward looking and subject to scenario and stress testing to ensure that the firm understands
what events might push the firm outside its risk appetite and/or risk capacity.
10 | © 2012 Global Association of Risk Professionals. All rights reserved.
Description:Senior Supervisors Group, “Observation on Development in Risk Appetite
Frameworks and IT . Strong linkage with the corporate strategy, capital and
budget. • Set the tone for Act as a brake against excessive risk-taking; Risk
appetite is determined as a result of successfully balancing betwe
