Do you know your institution’s risk appetite? That is, how much risk the board is willing to accept while working to meet profit objectives? If you don’t know, you’re not alone. Many institutions view risk appetite as an interesting risk management theory, but rarely do they effectively integrate risk appetite into their strategic planning or day-to-day decision making.
• Identify cross-function risks related to economic volatility (i.e., credit, liquidity, funding, operations, technology and reputation) and determine which risks require enhanced risk control and mitigation efforts
• Evaluate the adequacy of alternative risk management plans for different economic scenarios
• Develop, communicate and monitor risk appetite based on board review and concurrence
• Identify the essential components of ERM and assess whether those components meet your institution’s risk appetite and risk management needs
• Evaluate the effectiveness of ERM responsibilities, policies, procedures and controls to stay within risk appetite boundaries
• Conduct risk-based audits to ensure that ERM is meeting the Board’s risk appetite and risk management objectives
Without a well-defined risk appetite, an aggressive plan could lead to excessive losses. On the other hand, a conservative plan could lead to missed opportunities. You see, risk appetite provides a boundary around the amount of risk an institution might pursue. If there are no boundaries, there is little control over day-to-day decision making and profit targets can be easily missed. Just look at the institutions that failed during the Great Recession compared with the ones that thrived. The institutions that thrived knew how to stay within their risk appetite boundaries and avoided temptations to expand into risky markets. They knew their limits and communicated those limits to all employees as part of their enterprise risk management (ERM) program.
To embrace ERM, decision makers must know how much risk is acceptable as they consider ways of accomplishing objectives. For instance, lending to subprime borrowers can be risky, but with proper risk boundaries and considering all risks such as credit, interest rate, liquidity and reputation, it may be possible to take on a measured amount of subprime lending risk and still meet profit objectives. Integrating risk appetite with ERM is an effective way to balance risks and opportunities.