Do you Know Your
Risk Appetite?
As part of the development of a comprehensive compliance
management program, there are specific roles for senior management and another
set of roles for the Board of Directors.
Senior management has a functional role that includes the development of
written policies and procedures that are then presented to the Board for
approval. On the other hand, the Board
of Director’s role includes setting limits and overall policy guidelines. Among the most important roles of the Board
is to determine the overall risk appetite of the institution. Traditionally, the way that the Board
fulfills this function is by developing a risk appetite statement with metrics
for measuring adherence to the risk limits.
For Community Banks and small financial institutions, the idea of a risk
appetite statement and metrics may seem like a case of overkill. However, development of the risk appetite
framework can be an invaluable tool for strategic planning and resource
allocation.
In one way or another, all financial institutions are making
a statement about their risk appetite.
Some choose to consider appropriate risk levels directly and many more
do so indirectly. Each product and service
that is offered at an institution, vis-a-vis the resources that are dedicated
to compliance create a statement of sorts. When an institution decides to offer
products and services, compliance risks attach regardless of what those
products are. The compliance culture
that is developed to support products and services is, a form of a risk statement. The less emphasis that is placed on
compliance the higher the risk that the institution is willing to take. In many cases, when institutions get into significant
regulatory trouble, the root cause is an imbalance between risk appetite and
risk management. Offering a new product
without the proper systems in place to monitor compliance and without staff
that has the expertise to administer it, is the same as a statement that the
risk appetite is high.
Principles Associated with the Risk Appetite Framework
The idea here is that the Board, with the assistance of
Senior Management should develop the “rules of the road” for your
institution. If there are certain levels
of risk that the institution is/isn’t willing to take, then the Board should
clearly state that position. The same is
true for risk that the Board may be willing to take after consideration and
approval. For example, the Board may
state that it does not want the financial institution to make auto loans at
all. However, the best customer of the
institution tells a loan officer that he wants a car loan for his son. The loan officer believes that the customer
may be lost of he isn’t accommodated.
The auto loan is presented to the Board for approval and an exception
may be made.
The basic principles for a risk appetite should include at
least four considerations:
1.
The capital level of the institution;
Since capital is ultimately what keeps the institution alive a healthy level of
capital must be a consideration in the overall willingness to accept risk.
2.
Compensation of staff; The extent to
which staff compensation are tied to profits is a risk management
consideration. Incentives should be
weighted toward the idea that profit should be achieved within the risk
framework of the institution
3.
Customer Service; As mentioned above
there are times when meeting the needs of the customer base that the
institution is trying to maintain may require actions that are out of the
ordinary. The ability of your
institution to meet those needs should be considered in the risk appetite
framework. If your customer base happens
to be high risk, then the products and services that you will offer are also
high risk. [1]
4.
Compliance; For each consideration of
risk, there should be a consideration of the resources that will be allocated
to mitigate the associated potential for regulatory violations.
The risk appetite framework should be developed to balance
the interplay of the four principle areas of consideration. For example, a higher level of capital should
mean that the level of risk appetite is higher than when capital is low. Considerations of customer service have to be
tempered by capital levels; and so it goes.
Compliance as Part
of the Risk Appetite
There are many institutions that consider themselves either
low risk or no risk for compliance issues because limited retail products and
service are offered. However,
compliance is part of this overall process regardless of whether or not you’re
in a retail institution. There are
ALWAYS compliance issues. Regulations
such as the Equal Credit Opportunity Act, Anti-money laundering regulations and
Unfair Deceptive Abusive Acts or Practices regulations apply to all financial
institutions.
In any financial institution, there are competing interests,
and the need to achieve and maintain profitability is often the counterbalance
to taking increased risk. Banking is
after all at its essence, the management of risk. When the competing interests are out of
balance, the trouble starts. Today many
financial institutions find themselves searching for sources of income that are
different from the traditional positive net interest margins. The search for nontraditional income has led
to consideration of products such as short term loans, MSB’s and mobile
banking. Each of these products have a
level of inherent risk as well as substantial potential for profits. However, the compliance apparatus in place at
a financial institution can either significantly raise or reduce the level of
inherent risk. Over the past several
years, institutions have found themselves in regulatory trouble by offering
products that they either do not fully understand or have the necessary ability
to administrate.
There are many examples of institutions that have allowed
the push for profits to far outstrip the compliance program. In fact, on the websites of each of the major
regulatory agencies, there are examples of enforcement actions that have been
taken as the result of failure to properly maintain a compliance program.
Using the risk
framework to help with prioritizing
When a risk appetite framework is developed and implemented
even by a small financial institution, the overall effect on compliance is
positive. The process for developing the
framework forces a level of consideration and discipline on the Board and
senior management that is useful. The
risk appetite process is conducted by comparing the products and services that
that the institutions wishes to offer
with its ability to safely offer
those products and services.
When a new product is considered, it should receive the same
level of thought and consideration. High
risk products are not in of themselves a regulatory “no-no”. For each additional product or service, the
risk appetite of the Board should be considered along with the necessary
expenditure on compliance resources.
Remember the overall state of your CMP says a great deal
about your risk appetite.
FOR
MORE BLOGS, FORMS AND INFORMATION, PLEASE VISIT OUR WEBSITE AT WWW.VCM4YOU.COM
[1]
Please note- there are no regulatory bans on high risk customer or clients-
just a requirement that the high risks are properly managed.
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