Risk Profile, Strategic Planning, Risk Appetite – all this and more in the Supervisory Insights April 2016 edition and its companion video released in July. Remember when these were all discussed independently? Examining each within the Corporate Governance Program is now the new hot button with regulatory agencies.
Although 5 key elements of corporate governance are highlighted in the FDIC video and Insights publication, I thought I'd talk a bit about establishing an appropriate risk appetite.
This is a term that's surfaced recently - not necessarily new, but seems to be popular these days. What level of risk is your bank willing to accept for a target return or value? Page 9 of Supervisory Insights compares two bank profiles to illustrate what this means. It further defines RA as a set of objectives (narrative) and parameters (measures) within which management should operate.
Where are we now?
Traditionally one limit is set for the measures - the board policy minimum. And we get this question all the time: what do you suggest as risk limits for banks? Naturally, the answer lies in your own risk profile - it's different for everyone.
But we are now bringing risk into the bank strategic planning process and best practices would include setting both high and low ranges, using multiple metrics, and tracking progress.
In the example above, if T1 capital were above 10%, then using the risk guideline columns, the bank would be in a low risk situation. If it were below 8%, the bank would be in a high risk situation. And if it's somewhere in between, that's a moderate status.
Although many of the metrics go beyond the board approved policy, the board should be involved in choosing and monitoring results. Ever helpful, Insights says: "There is no single list of areas for which directors should set risk objectives and parameters."
So, in addition to Capital, as illustrated above, Quality, Earnings, Liquidity, and Sensitivity to Market Risk (CAELS) should be included in a complete plan. An important exercise in your bank's strategic planning process should include choosing the metrics and setting your low and high risk limits. I would read page 11 for more clarity.
Where do we want to be?
Taking it a step further, the FDIC suggests looking past the current situation. Are you low status and trending the wrong direction? What is the forecasted outlook for this metric? To measure this, you'll need a forecast plan, with some assumptions on growth, new business lines, and forcasted market rates. This forces the board and senior management to consider what action to take based on trends and forecasts.
The next logical questions are "How do we get there?" and "How will we know when we are successful?". Answer all four questions and you have the base for setting your bank's strategic plan, one of the other key elements in corporate governance.
For a more detailed understanding, you might want to check out Illinois Bankers Association Setting Your Risk Appetite - a one day seminar on the topic taking place later this month.