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How to define and implement a Risk Appetite Statement Concept | Methodology | Technology. IOR Scottish Chapter 2 nd Annual Conference Glasgow Caledonian University October 26 th , 2012. Setting the scene.

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how to define and implement a risk appetite statement concept methodology technology

How to define and implement a Risk Appetite StatementConcept | Methodology | Technology

IOR Scottish Chapter 2nd Annual Conference

Glasgow Caledonian University

October 26th, 2012

setting the scene
Setting the scene

"People know risk appetite is important, and they think they've got it. But the industry is still falling short on how to think about it [Risk Appetite]..."

"Our challenge as non-executives is there is no definition. We are dealing with words, not well-understood and agreed concepts. There's no 'hitchhikers' guide' to risk appetite and no agreement there should be one"

Tapestry Networks, Inc - Bank Governance Leadership Network, Insights from the non-executive dinners, June 16, 2010

objectives
Objectives
  • To provide a practical approach to define and deploying risk appetite as a strategic management tool
  • Explain the role of risk appetite within the overall strategy process
  • Outline the steps and process around building a robust Risk Appetite statement

Provide a ‘Hitchhikers guide’ to Risk Appetite!

slide4
The credit crunch and subsequent fall-out is rewriting the rules on strategy execution and risk management
corporate governance weaknesses related to risk appetite contributed to the credit crunch
Corporate governance weaknesses related to Risk Appetite contributed to the credit crunch

Supervisors see insufficient evidence of board involvement in setting and monitoring adherence to firms’ risk appetite.

Risk appetite statements are generally not sufficiently robust; such statements rarely reflect a suitably wide range of measures and lack actionable elements that clearly articulate firms’ intended responses to losses of capital and breaches in limits.

Board-level engagement in risk oversight should be materially increased, with particular attention to the monitoring of risk and discussion leading to decisions on the entity’s risk appetite and tolerance.

Remuneration structures for all such “high end” employees are appropriately aligned with the medium and longer-term risk appetite and strategy of the entity.

In essence, the obligation of the board in respect of risk should be to ensure that risks are promptly identified and assessed; that risks are effectively controlled; that strategy is informed by and aligned with the board’s risk appetite; and that a supportive risk culture is appropriately embedded so that all employees are alert to the wider impact on the whole organisation of their actions and decisions.

post credit crunch uk corporate governance code was updated to be more specific about risk appetite
Post credit crunch, UK Corporate Governance Code was updated to be more specific about Risk Appetite

The UK Corporate Governance Code issued in May 2010 states that ‚the Board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives…and should maintain sound risk management and internal control systems.

organisations are increasingly looking to risk management as a source of competitive advantage
Organisations are increasingly looking to ‘Risk Management’ as a source of competitive advantage

64%

Almost two-thirds of Risk Masters 64% indicate that their risk management capabilities provide competitive advantage to “a great extent,” compared with only 42% of the peer set.

Neither too cautious nor too reckless, the best companies use their risk management capabilities to adjust either their capacity or their appetite to make more prudent— and ultimately successful— investment decisions.

Source: Accenture 2011 Global Risk Management Study

evidence suggests many corporate governance weaknesses and board level challenges still exist
Evidence suggests many corporate governance weaknesses and Board level challenges still exist

“the Board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic goals.” UK Corporate Governance Code, 2010

21%

“only 21% align their risks with their business strategy”

– Grant Thornton Corporate Governance Review 2011

Where the Board need to spend more time…

70%

Strategy

“results indicate a need to better educate Boards on industry dynamics and how their companies create value...”

42%

Execution

47%

Performance Management

21%

“Only 21% of directors surveyed claim a complete understanding of their companies’ current strategy”

– Mckinsey Global Survey – Corporate Governance, 2011

67%

Risk Management

Approx. 1500 participants

the definition of risk appetite is clear but the application is less well understood
The definition of Risk Appetite is clear, but the application is less well understood
  • The COSO definition provides ‘What, Who, When and Why’ of risk appetite
    • What: the amount and type of risk
    • Who: an organisational entity 
    • When: over a defined time horizon  
    • Why: to achieve the objectives of the entity

Risk appetite is the amount and type of risk that is acceptable to be taken by an organisational entity over a defined time period, to achieve the objectives of that entity – COSO Enterprise Risk Management

Risk appetite sets the boundaries within which strategy is executed

– Manigent

slide10
Risk Appetite is a multidimensional construct, which changes depending on the organisational entity and its objectives

Annual

90 days

Overnight

Investment Banking example

We are willing to put £x million of capital @ risk to trade on our own account over the next 12 month period.

We hold no more than x% of our capital in overnight positions.

We will accept operational losses of £x million per month.

Extreme

High

Moderate

Low

Water Industry example

We have no appetite for causing customer illness by supplying poor quality water.

We have no appetite for appearing in local press related to leaks or fines for more than 2 consecutive days.

Credit

Market

Liquidity

Operational

Strategic

risk appetite setting process
Risk Appetite Setting process

4. Board appetite setting workshop(s)

1. Joint Board / Executive appetite familiarisation workshop(s)

2. 1-2-1 follow-up meetings

3. Joint risk dimension workshop(s)

5. Joint Appetite setting workshop (s)

6. Joint Board / Executive Appetite sign-off

4. Executive appetite setting workshop(s)

  • This process is designed to quickly establish the organisational boundaries – risk appetite.
  • Step 3 can be combined with either step 2 or 4.
  • Splitting the workshops in step 4 is designed to bring out different views / perspectives, but these can be combined.
defining risk appetite in seven steps
Defining Risk Appetite in Seven Steps

To design a robust risk appetite statement follow these steps:

  • Identify the Key Value Drivers for the Business
  • Define Risk ‘Buckets’ based on Key Value Drivers
  • Define a set of Strategic Objectives
  • Define and Assess a set of Key Risks
  • Align Risk-taking to Strategy
  • Define the Risk Appetite statement
  • Monitor the Alignment of Risk-taking to Appetite
1 identify the key value drivers for the business
1. Identify the Key Value Drivers for the Business

Identify strengths & weaknesses

Business Goals

Identify threats & opportunities

Internal Analysis

External Analysis

Is our business model fit for purpose?

Is our business model fit for purpose?

Business Drivers

Formulation

Develop the strategic plan

Appetite

Business Model

Business Objectives

Distil strategy into actionable objectives with defined appetites

Setting

Appetite

Strategy

Are we on-track to deliver?

Are we operating within appetite?

Continuously align and monitor risk taking to business strategy

Execution

Performance Management

Appetite

Risk Management

Manage strengths & weaknesses

Manage threats & opportunities

Appetite Alignment

1 identify the key value drivers for the business cont
1. Identify the Key Value Drivers for the Business cont.

Strategy Management

What are we trying to achieve?

What is our Risk Appetite?

Performance Management

Risk Management

Are we on track?

Are we operating within appetite?

Appetite

Governance & Communications

Culture

1 identify the key value drivers for the business cont1
1. Identify the Key Value Drivers for the Business cont.

Business drivers

Shareholder value

Strategy

Capital

Share price

Manage

Performance

Appetite

Manage

Risk

Income

Economic value add

Reputation

Profit

Align Risk-taking to Strategy

Communication

Governance

Appetite

Culture

2 define risk buckets based on key value drivers
2. Define Risk ‘Buckets’ based on Key Value Drivers

Business Drivers

Low

Moderate

High

Extreme

Capacity Limit

Income

X% Capital

@Risk

X% Capital

@Risk

X% Capital

@Risk

X% Capital

@Risk

Capital

Up to

X £M

X £M to

Y £M

X £M to

Y £M

X £M to

Y £M

Above

X £M

Reputation

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

2 define risk buckets based on key value drivers cont
2. Define Risk ‘Buckets’ based on Key Value Drivers cont.

Business Drivers

Low

Moderate

High

Extreme

Capacity Limit

Income

X% Capital

@Risk

X% Capital

@Risk

X% Capital

@Risk

X% Capital

@Risk

Capital

Up to

X £M

X £M to

Y £M

X £M to

Y £M

X £M to

Y £M

Above

X £M

Reputation

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

4 define and assess a set of key r isks
4. Define and Assess a set of Key Risks

The risk of (what, where, when)….. caused by (how) ……resulting in..…(impact/consequences)

Examples

  • The risk of financial deficit at end of year caused by decreased in-patient activity and revenue, resulting in rationalisation of service offerings.
  • The risk of exceeding A&Ewaiting times, caused by increased demand and staff vacancies, resulting in not meeting community expectations and adverse patient outcomes
4 define and assess a set of key risks cont
4. Define and Assess a set of Key Risks cont.

The risk of (what, where, when)….. caused by (how) ……resulting in..…(impact/consequences)

Examples

  • The risk of financial deficit at end of year caused by decreased in-patient activity and revenue, resulting in rationalisation of service offerings.
  • The risk of exceeding A&Ewaiting times, caused by increased demand and staff vacancies, resulting in not meeting community expectations and adverse patient outcomes
6 define the risk appetite statement
6. Define the Risk Appetite statement

Business Drivers

Low

Moderate

High

Extreme

Capacity Limit

Income

X% Capital

@Risk

X% Capital

@Risk

X% Capital

@Risk

X% Capital

@Risk

Capital

Up to

X £M

X £M to

Y £M

X £M to

Y £M

X £M to

Y £M

Above

X £M

Reputation

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

Up to X vol. Bad coverage

7 monitor the alignment of risk taking to appetite
7. Monitor the Alignment of Risk-taking to Appetite

Appetite sets the boundaries for the business within which they execute strategy and create value.

Therefore the Appetite Alignment Matrix provides a method of visually monitoring and managing our risk taking according to the strategy, identifying where too much or not enough risk is being taken.

Reputation @Risk

Capital

@Risk

Impact x Likelihood

(over a time horizon)

7 monitor the alignment of risk taking to appetite1
7. Monitor the Alignment of Risk-taking to Appetite

Strategy Map

Risk Map

Appetite Alignment Matrix