Risk appetite framework: challenges in effective implementation and its integration into management

First Annual Risk Conference 2023

What it is about

Juan Carlos Estepa Jiménez, of Nemesis, explained at the First Annual Risk Conference (September 21, 2023) how the risk management model is evolving and how to build and use a risk appetite framework (RAF) integrated with portfolio management.

The 40 slides contrast traditional credit risk management with advanced management, explain the benefits of the appetite framework and the consequences of not setting it up well (with the Lehman Brothers case), detail the appetite and tolerance statement with primary and secondary indicators, and show how the asset allocation exercise carries appetite into capital allocation by segment and sector, with limits and monitoring.

Objectives

Contrast traditional risk management, focused on control, with advanced management that sees risk as part of value creation.
Explain the elements of a risk appetite framework and its appetite and tolerance statement.
Show how asset allocation and limits turn appetite into measurable portfolio decisions.

Key takeaways

In the advanced approach, risk is intrinsic to banking and an essential component of value creation; the goal is not to eliminate it but to manage it.
Not setting risk appetite properly has serious consequences; the Lehman Brothers case is presented as an example.
The appetite and tolerance statement combines primary and secondary indicators, with tolerance levels that trigger actions when exceeded.
Asset allocation identifies the portfolios that create the most value for the capital consumed, using metrics such as risk-adjusted margin over capital, within the appetite's constraints.
A prudent risk management culture, a countercyclical provisioning policy and proactive management of the whole credit life cycle are recommended.