Wednesday, July 31, 2013

A Risk Appetizer

Flying under the media radar in the last couple of weeks was a very important announcement by the Financial Stability Board (FSB).  On July 17, the Board released a Consultative Document on the Principles for an Effective Risk Appetite Framework.  The press release stated:  "The Principles will enhance supervisory oversight of firms, in particular of systemically important financial institutions (SIFIs), by establishing minimum expectations for the key elements contained in an effective risk appetite framework, such as: an actionable risk appetite statement; quantitative risk limits; and clearly defined roles and responsibilities of the board of directors, senior management and business lines."

An aim as important as the minimum expectations is "to establish a common nomenclature for terms used in the risk appetite framework, which will help to facilitate a common understanding between supervisors and firms and to narrow any gaps between supervisory expectations and firms’ practices." 

For readers of The National Bank Examiner who are not bankers, bank directors, or bank supervisors:  An effective risk appetite framework is the foundation of good risk management.  A bank’s risk appetite represents the aggregate level and types of risk the bank is willing to assume within its risk capacity to achieve its strategic objectives and business plan, and this should be set out in written form in a risk appetite statement.  The bank’s risk appetite statement should be linked to the bank’s short- and long-term strategic, capital and financial plans, as well as compensation programs.  It should assess the bank’s material risks under both normal and stressed market and macroeconomic conditions, and set clear boundaries and expectations by establishing quantitative limits and qualitative statements for risks that are difficult to measure.

To gain a full appreciation for the bank's risk appetite, it's also important that the risk appetite statement be able to be viewed from a minimum of six optical angles: consolidated entity, business line, legal entity, product line, balance sheet concentrations, and by geography.

Incidentally, a reminder to foreign banks with presences in the United States.  Foreign Banking Organizations (FBOs), with assets in the United States, need to pay particular attention to the issue of geography, as the Board of Governors of the Federal Reserve has a pending regulation that would require the establishment a U.S. Risk Committee for any FBO with global assets exceeding $10 billion, regardless of the size of its U.S. presence.  Even community bank-sized FBO presences in the U.S. will need to operate under the umbrella of a U.S.-specific risk management architecture.

As many of you know, who have wrestled with the task of creating a risk appetite statement for on-strategy and off-strategy risk management at the board of directors level, the lack of an industry standard or common practice guidelines make the effort both frustrating and time-consuming.  For each bank, the risk appetite statement wheel gets invented over and over again, amply profiting the bank consultants brought in to facilitate the process with their own in-house incarnations of how a risk appetite document ought to be prepared.

A global industry standard established by a common set of expectations and a shared risk management language, would really advance the ball in this necessarily  fundamental, and perhaps, the trickiest part of a bank's risk management architecture.  While these principles are designed to apply primarily to SIFIs, the concepts behind them are universally applicable, the difference being that of scale and complexity. 

The Financial Stability Board is welcoming comments on this Consultative Document until September 30th, 2013.  I would advise that you consider overlaying the template outlined in the Consultative Document over your own bank's risk appetite statement.  If your risk appetite statement has aspects or dimensions that are not in the FSB template, but which you feel especially proud or fond of, and that you also consider fundamentally important to the proper design and practical application of a risk appetite statement, please let the Financial Stability Board know at

If you are interested in following one of the premier thinkers in the area of banking risk management, let me also refer you to the writings of Dennis Chesley, Global Leader of Risk Consulting at PwC  and the PwC Resilience website.  I don't hawk the wares of banking consultants, that's caveat emptor for the buyer, but I do occasionally want the readers of  The National Bank Examiner to consider bookmarking their browsers to the published products of the current  "thought leaders" in our industry.  Their morsels of shared wisdom are free, and the enlightenment that may come to you from connecting-the-dots, or a pop-up insight, or even an "aha! moment", can be very valuable.

I had the personal privilege of working with Dennis as a fellow member of the team that stood up, and made operational, the U.S. Government's Troubled Asset Relief Program (TARP) in the dark days of early October of 2008.  As an important member of what forever will be a unique "band of brothers and sisters", Dennis and his team helped the government officials involved design the internal controls and risk management architecture surrounding what is, thus far, the largest and fastest delivery of U.S. Government financial assistance to Corporate America in the history of the United States.

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