The Society has responded to the Discussion Paper on Risk Appetite issued by the Central Bank of Ireland recently.
In general, the experience of our members is that the discipline of explicitly considering risk, including quantifying risk capacity and articulating risk appetite, promotes an improved understanding of risk. The articulation of risk appetite has facilitated greater transparency and understanding of risk at Board and Risk Committee level. Articulating risk appetite also promotes risk monitoring to ensure that risks accepted remain within the parameters defined by the Board.
We therefore recognise the value of articulating risk appetite, both quantitatively and qualitatively.
We caveat this by saying that:
(a) It is important to recognise that a Risk Appetite Statement is a tool, rather than a sure mechanism for avoiding inappropriate risk; and that risk appetite must be determined with appropriate regard for risk capacity – the quantification of which may be subject to considerable uncertainty.
(b) Articulating risk appetite may be counterproductive if not combined with a robust and independent assessment of the calibration of risk appetite, taking into account the capacity of each company to adopt its stated risk appetite. Without proper supervisory engagement and oversight in the area of risk appetite, there is a risk that a company may pursue inappropriate objectives, thereby defeating the purpose of the risk appetite framework and potentially increasing risk overall.
Thus, we caution that, used inappropriately, the risk appetite framework could be fundamentally flawed and could lead to bad decision-making within companies, particularly if combined with poor supervisory oversight.
That said, we believe that the articulation of risk appetite clearly facilitates engagement between the Central Bank and regulated companies. We suggest that the supervisory focus should be on assessing the appropriateness of each company's risk appetite in the context of that company's particular situation and circumstances. This could be done under the Central Bank’s PRISM framework.