Introduction
"Increasing the intensity and effectiveness of supervision is a key component of the Financial Stability Board's (FSB's) framework, endorsed by G20 Leaders, to reduce the moral hazard of systemically important financial institutions (SIFIs). As such, supervisory expectations for risk management particularly at SIFIs are increasing. The October 2011 FSB progress report on enhanced supervision noted that effective risk appetite frameworks (RAFs) that are actionable and measurable by both financial institutions and supervisors have not yet been widely adopted. It concluded that the development of an effective RAF is important for financial institutions and supervisors, and needs attention by both. The report recommended that supervisors discuss expectations for what a "good" risk appetite framework entails and how to supervise against these expectations. In light of these findings, the FSB launched a peer review on risk governance which was published in February 2013. Based on the findings of the review five recommendations were set out, one of which asked the FSB to develop, in collaboration with relevant standard setters, guidance on the key elements contained in an effective RAF. The report also recommended the FSB to establish common definitions for terms used in RAFs to facilitate communication between supervisors and financial institutions, as well as within financial institutions (see Section II). The FSB Principles set out key elements for: (i) an effective risk appetite framework, (ii) an effective risk appetite statement, (iii) risk limits, and (iv) defining the roles and responsibilities of the board of directors and senior management (see Section III). The Principles aim to enhance the supervision of SIFIs but are also relevant for the supervision of financial institutions and groups more generally, including insurers, securities firms and other non-bank financial institutions. For non-SIFIs, supervisors and financial institutions may apply the Principles proportionately so that the RAF is appropriate to the nature, scope and complexity of the activities of the financial institution. An appropriate RAF should enable risk capacity, risk appetite, risk limits, and risk profile to be considered for business lines and legal entities as relevant, and within the group context. Subsidiaries of groups, in particular of SIFIs, should have a risk appetite statement that is consistent with the institution-wide RAF and risk appetite. The elements of the RAF should be applied at the business line and legal entity levels in a manner that is proportionate to the size of the exposures, complexity and materiality of the risks. Materiality should be determined by financial institutions, and discussed with supervisors, in accordance with their internal assessments of risk appetite, risk capacity and risk profile, having regard to capital, liquidity and earnings at the entity level. The FSB Principles are high level to allow financial institutions to develop an effective RAF that is institution-specific and reflects its business model and organisation, as well as to enable financial institutions to adapt to the changing economic and regulatory environment in order to manage new types of risk. Establishing an effective RAF helps to reinforce a strong risk culture at financial institutions, which in turn is critical to sound risk management. A sound risk culture will provide an environment that is conducive to ensuring that emerging risks that will have material impact on an institution, and any risk-taking activities beyond the institution's risk appetite, are recognised, escalated, and addressed in a timely manner. Supervisors should take steps to ensure financial institutions, in particular SIFIs, meet these Principles, and should regularly discuss with financial institutions any changes to its RAF, breaches in risk limits, significant deviations from the approved risk appetite statement, as well as any material risks that the RAF does not adequately address. In the case of international groups, the RAF should be routinely discussed and assessed by supervisors, including at supervisory colleges." |