Question

The aligning of the risk appetite with the business strategy is an integral part of setting the operational risk appetite, and therefore, vital that it is driven by top management. Briefly discuss the role and responsibility of top management in terms of setting a realistic operational risk appetite. (The maximum length of your answer is 1 page).

Answer 1

Risk appetite is the aggregate levels and types of risk that an organisation is willing to take within its risky capacity.It is a critical tool for effective decision making and project performance management and therefore it should be driven by the top management.

The overall approach including policies, process, limits, controls and systems through which the operational risk appetite is established, communicated and monitored must be planned and implemented by top management.The expectations about how this framework will work strike at the heart of how organisations manage their businesses.At the highest level, the risk appetite framework must be alligned with the business plan and strategy. In other words, in setting the annual plan, the board and management must consider whether it is consistent with the risk appetite, and any significant changes in strategy need to be assesed against risk appetite.However, going far beyond this, a common framework of measures must be agreed upon and communicated and then spread through the organisation to guide individual decisions on a day to day basis.

The senior management must involved in the setting of operatioanl risk appetite which includes incorporating risk appetite in compensation, day to day operations, decision making processes as well as ensuring that business planning is consistant with it and that new products are assessed against it, along with atrategic changes such as mergers.In addition, capital management must be appropriate given the risk appetite.Some of the major responsibilities of top management in relation to risk appetite are the following:

1) Establish a prudent risk appetite that is consistent with the firm's short and long term strategy, business and capital plans, risk capacity and compensation programs and align it with supervisory expectations.

2) Be accountable, together with the business lines, for the integrity of the risk appetite framework, including the timely identification and escalation of breaches in risk limits and of material risk exposures.

3) Ensure that the risk appetite is appropriately translated into risk limits for business lines and legal entities, and that business lines and legal entities incorporate risk appetite into their strategic and financial planning, decision making process and compensation decisions.

4) Provide leadership in communicating risk appetite to internal and external stakeholders so as to help embed prudent risk taking into the firm's risk culture.

5) Independently monitor business line and legal entity risk limits and the firm's aggregate risk profile to ensure they remain consistent with the firm's risk appetite.