Danièle Nouy of ECB spoke at the International Conference on Banks’ Risk Appetite Frameworks in Ljubljana. She defined the risk appetite framework and explained how to judge the quality of risk appetite frameworks. Then, she discussed the current state-of-play regarding the risk appetite frameworks of banks and discusses the improvements banks need to make in their frameworks.
Ms. Nouy explains that the risk appetite frameworks should be comprehensive, effectively governed, consistently used, and fully integrated into strategic decision making. After explaining the expectations from banks, she moved on to highlight the progress made by banks. She added that the risk appetite frameworks of banks are now better structured and subject to clearer governance. For instance, most banks have clarified the role of the relevant stakeholders involved in the risk appetite framework. Moreover, in many banks, internal auditors have reviewed the effectiveness of risk appetite frameworks. Many of these frameworks cover a broader set of risks than before. Most banks go beyond the regulatory minimum to define metrics that are more suited to their business models. Ms. Nouy believes that, despite this progress, banks need to improve their frameworks and then points out four things that banks need to work on:
- Non-financial risks should be better covered (and not be completely left out). If a bank cannot put concrete numbers to these risks, it should at least use qualitative statements.
- The governance of risk appetite frameworks must be further improved. Boards need to play a bigger role in the definition and review of risk appetite frameworks.
- Banks must use risk appetite limits as a tool to monitor their risk profiles, keep risks in check, and set the right incentives for the organization.
- Banks need to embed risk appetite frameworks in their strategic processes.
She emphasizes that banks need to take a holistic approach to risk culture and risk management, including risk appetite. “These things need to be perfectly attuned. And they need to be in harmony with the rest of the organization—with the business model and with remuneration schemes, among other things. This framework needs to be an integral part of the decision-making process.” She added that most banks do not use risk appetite limits and statements as tools to facilitate discussion at various levels of the organization. They need to change this approach and create better incentives for complying with risk appetite frameworks. “Here, the tone from the top plays a crucial role. It is those at the top who have to promote a sound risk culture—by putting it into practice, by acting as role models. The board and the senior management must define values and set expectations for the risk culture. The board in particular must challenge the senior management and so ensure that each and every strategic decision is based on a sound risk analysis. Moreover, having a sound infrastructure for risk data would make this easier to achieve.”
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