What is Bank Risk Appetite?

In general, the definition of risk appetite is the amount of risk that can be accepted / tolerated by the bank. In the context of supervision, the Financial Services Autority (FSA) UK defines risk appetite as the amount of risk that banks have to be ready whenever a bad things happened. Banks can use risk appetite in expressing what level of acceptable risk and providing certainty for bank stakeholders.

In practice, when talking about risk appetite, the bank uses the tolerance limit approach. Tolerance Limit / risk tolerance is level of relative variation at the acceptable risks incident to the achievement of bank objectives strategic. In other words, risk tolerance is the level where the risk event occurring would not disturb the achievement of the bank.



According Pillar 2 of Basel II, the Directors are required to have a process for assessing bank capital requirements, known as ICAAP as a basis for assessing the risk appetite of the bank. Although not entirely describe the aggregate risk faced by banks, the minimum capital requirements can be used as a starting point determining the risk appetite of the bank.

One measurement that can be used to measure the risk faced by the bank is the limitation of financial distress associated with the probability of a bank downgrades by rating agencies recognized. As is known, the rating downgrade will increase the cost of bank funding and can lead to the decline in the bank's ability to obtain funding from depositors or the money market.

To fulfill the stakeholders expectations, risk appetite in the form of corporate risk tolerance levels set in line with corporate strategy. Then presented in the form of risk tolerance for each category of risk for each business unit. Risk tolerace per risk categories are then presented in the form of limit risk category per department and per product by Business Unit.

Illustration of the application of risk appetite is exemplified as below:

NPL: set 2% with a probability that does not exceed 5% NPL is above 2%.

Rating Bank: targeted worst AA is A +

CAR: 3% above minimum requirements which the deviation is expected not to exceed 10%.

Risk appetite can be translated into quantitative statements relating to i). Estimated credit losses, ii). an uncertain income, iii). losses that may occur in the macroeconomic cycle, iv). expected losses in the most extreme possible level, v). portfolio concentration, vi). capital adequacy ratio and vii). credit rating. In addition, risk appetite can also be described through qualitative statements relating to i). Activity business, ii). business implementation, iii). business performance etc..

Source: www.bankirnews.com