BIS paper advocates supervisory risk appetite frameworks
The Bank for International Settlements (BIS) has published a paper advocating for supervisory risk appetite frameworks (RAFs). These frameworks aim to strengthen supervisory governance and culture, addressing weaknesses exposed by recent banking crises.
Managing inherent supervisory risks
Recent banking crises highlighted significant weaknesses in bank governance and supervisory effectiveness.
Supervisory authorities (SAs) often struggle to identify and address material risks before they escalate, with cultural shortcomings frequently at the root.
The paper defines 'supervisory risk' as the risk that an SA's actions or inaction fail to achieve prudential objectives.
This risk stems from internal factors like weak governance or external constraints.
Supervisory risk cannot be fully eliminated; SAs operate with finite resources and imperfect information, requiring management of inherent trade-offs.
Risk appetite frameworks (RAFs), tailored to SAs' safety and soundness mandate, offer a structured approach.
RAFs define acceptable supervisory risk boundaries, align strategic goals with daily supervision, and facilitate prioritisation and risk-based decision-making, fostering consistency and accountability.
Tailoring frameworks for supervisors
International standards do not explicitly require supervisory authorities (SAs) to develop risk appetite frameworks (RAFs), unlike for banks.
This has led to limited adoption, with Canada's OSFI and the ECB/SSM being exceptions.
The paper proposes a framework for designing and implementing SA-tailored RAFs to enhance governance, culture, and effectiveness.
This involves defining supervisory risk, formulating clear risk appetite scales, developing high-level risk appetite statements (RAS), operationalising RAS through indicators, and establishing robust governance with an independent second line function.
Overdue clarity for complex mandates
The paper highlights a critical gap in supervisory frameworks, offering a structured path to enhance accountability and effectiveness in a complex environment.
While not a silver bullet, formalizing supervisory risk appetite provides essential transparency for stakeholders and internal decision-making.
Its adoption could significantly improve the resilience of financial systems by proactively addressing supervisory vulnerabilities and fostering a stronger risk culture within authorities.