by Noriyuki Morimoto
The Principles for an Effective Risk Appetite Framework, announced by the Financial Stability Board on November 2013, is a management framework that sets out elements of a financial institution’s healthy risk appetite, including risks they should willingly accept in order to achieve their business objectives.
According to the Financial Services Agency, the framework features “risk appetite” as the aggregate level and types of risk that a financial institution is willing to accept in order to achieve its business objectives, based on business models specific to each institution. It is intended to be used as an internal common language to manage overall risk-taking policies, including capital allocation and maximization of profits.
Japanese megabanks have also formed what should be their risk appetite frameworks and disclosed summarized versions of them, but without any specific description of risks they would willingly accept. They have only written down the structures in which they manage risks they actually take in a passive manner.
What triggered the implementation of risk appetite frameworks was the lesson learned from the global financial crisis of 2008. Apparently, one cause of the crisis recognized by regulatory authorities was the management practices of major financial groups: their pursuit of profit without strategic objectives, which led them to lose sight of the finance industry’s role in society and to fail to fulfill their responsibility towards their customers. In other words, financial institutions had decided on which risks to accept from the viewpoint of putting profit above all.
Consequently, financial institutions have since been required to reestablish their specific business models and redefine risks they willingly accept. This is an initiative for financial institutions to increase corporate value in the mid- to long-term, as a priority over pursuing short-term profits.
Given that megabanks select the risks they willingly accept based on their specific business models, their healthy sensibility for risks is being tested here. When you liken that sensibility to taste, the cause of the financial crisis may be described as an overwhelming urge to relieve hunger: to pursue profits regardless of taste. In the risk appetite framework, institutions are expected to take sensible risks according to their own sophisticated taste cultivated in their culture.
So there is supposed to be a shift from the tasteless pursuit of profit to tasteful creation of value, but can’t the megabanks tell good taste from bad?
Chief Executive Officer, HC Asset Management Co.,Ltd. Noriyuki Morimoto founded HC Asset Management in November 2002. As a pioneer investment consultant in Japan, he established the investment consulting business of Watson Wyatt K.K. (now Willis Towers Watson) in 1990.