Risk Alert Newsletter



Steps in adopting Risk Appetite


Steps in adopting Risk Appetite

There is no single universally acceptable risk appetite. Therefore, each organization must determine its own risk appetite.

For an organization to get to the point of having a risk appetite statement that can still be relevant over time, it must take the following 3 key steps: 

  • Management must develop, with board review and concurrence, a view of the organization’s overall risk appetite.
  • This view of risk appetite is translated into a written or oral form that can be shared across the organization.
  • Management monitors the risk appetite over time, adjusting how it is expressed as business and operational conditions warrant.
  • We can buttress this last point with examples from the recent past, of the developments in the stock market that contributed to the distress in the banking sector.

 

 Bank A had huge appetite for risks and this made the officials to continue to tinker with the portfolio so as to accommodate the opportunities in the stock market in the time of boom. At a point, the total exposure of the bank to margin loans was one of the highest in the industry. Some authors have persistently argued that there may not be anything too bad in having huge appetite but there is everything wrong with not developing necessary control and mitigating techniques, especially in the area of monitoring and exiting where appropriate. This particular bank failed in this regard by not acting precisely and appropriately. It did not develop active, effective and intelligent radar that should have enabled the executives to know when to wind down its investments in the market.

 

Bank B on the other hand emerged from a capital market background. It is one of the leading investment banks but was also exposed to the market. However, the bank was strongly and seriously scanning the local environment, and monitoring every development in the external (foreign) markets. At a time when other banks in the industry were still undecided on what to do, Bank B started winding down, and this made the bank to lose little or nothing to the market ‘tsunami’.

 

What lessons can you deduct from these?

Your feedbacks and comments will be highly welcomed

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