On 10 April 2018, the European Central Bank (ECB) published a speech given by Danièle Nouy (Chair of the Supervisory Board, ECB) entitled Risk appetite frameworks: good progress but still room for improvement.
In her speech Ms Nouy discusses how the ECB judges the quality of banks’ risk appetite frameworks focussing on whether they are comprehensive, effectively governed, consistently used and fully integrated into strategic decision-making.
In particular Ms Nouy states that a bank’s board should be involved with the risk appetite from the start. It should play a key role in setting and approving the risk appetite framework. But it should also oversee the framework’s regular review and its proper implementation. The ECB expects the board to significantly influence the way in which the framework is set up and challenge whether it is being implemented in line with the bank’s strategy.
Ms Nouy states that banks have generally made progress in developing their risk appetite frameworks but highlights four areas that they still need to work on:
- non-financial risks are often insufficiently covered or even completely left out of the framework. This includes risks such as compliance and reputational risks, IT risks, legal risks and conduct risks;
- boards need to play a bigger role in the definition and review of risk appetite frameworks. The same is true for banks’ risk function. Many banks need to enhance the role this function plays, in particular when it comes to defining and approving limits;
- banks also need to work on how they calculate and actually apply the limits of their risk appetite frameworks. Even where limits are breached, a report is triggered but no meaningful action follows. The ECB expects banks to use risk appetite limits as a tool to monitor their risk profiles, keep risks in check and set the right incentives for the whole of the organisation;
- how the risk appetite framework is embedded into strategic processes. Banks need to take a holistic approach to risk culture and risk management, including risk appetite. Too many banks still wrongly see their risk appetite framework as a separate tool, unrelated to decision-making. The framework needs to be an integral part of the decision-making process. Here, the tone from the top plays a crucial role.