Risk Appetite in

Banking

Steve Townsend

Tesco Bank

Agenda1. Risk Appetite

2. How a bank fails - Capital & Liquidity Risk

3. Linking Risk Appetite to Strategy

4. Strategic Risk Measures

5. Capacity, Limits & Triggers

6. Stress Testing & Business Planning

7. Critical Success Factors & Challenges

Questions?

A Regulatory Requirement!

1. Risk Appetite

1.1 Risk Appetite Definition‘Risk appetite is the level and type of risk a firm is willing to assume in its exposures and business activities, given its business objectives and obligations to stakeholders.’

.

Risk appetite is generally expressed through both quantitative and qualitative means and should consider extreme conditions, events and outcomes. In addition, risk appetite should reflect potential impact on earnings,

capital and funding / liquidity.

2. How a bank fails

…… or both!

Not enough liquidity

Not enough capital

2.1 Capital Risk

Macro economics

Credit losses / Bad debts

Volumes

Margin erosion

Pension deficits

Rogue trading losses

2.2 Liquidity Risk

New bank: £10,000 capital

1. Accepts Deposit £100k –Instant Access

2. Lends £100k mortgage for 25 years

3. Depositor requests £100,000 withdrawal

Bank can’t pay – insolvent

But no loss and £10,000 capital is intact

Established bank: £10bn capital

1. Accepts Deposits £100bn -Instant Access

2. Lends £90bn mortgage for 25 years

3. Retains Liquidity buffer £10bn

4. Depositors request £15bn withdrawals

5. Bank borrows £5bn

Bank can pay – solvent

Still no loss and £10bn capital is intact

Strategic Risk Objectives

Strategic Business Objectives

Strategic Risks

Scale andefficiency

Groupstrength

Profit volatility and

return on capital

Customerloyalty

Regulatory compliance People/Values

Customerservice & products

Financial Strength

Customer Experience

Market Reputation

Regulatory Compliance

8

Operations& People

Reputational Risk

A positive stakeholder perception

A fit for purpose,scalable operating model

Financial Risk

Acceptable Profit Volatility & Financial Strength

3. Risk Appetite: Linking Risk Appetite to Strategy

Profit Volatility

Financial Strength

Market Reputation

Customer Experience

Regulatory Compliance

3rd Party & Outsourcing

Process People Technology

9

FINANCIAL RISK REPUTATIONAL RISK OPERATIONS & PEOPLE RISK

Profit Volatility

Financial Strength

Market Reputation

Customer Experience

Regulatory Compliance

Process People Technology3rd Party &

Outsourcing

4. Risk Appetite: The Strategic Risk Measures

- Profit 1 in 20- Capital ratios- Liquidity

- Debt rating- Customer Retention- Complaints- Regulatory engagement

- Change- Staff Attrition- IT availability- Change- Systems integrity- Outsourcing/Suppliers

5. Risk Appetite: Capacity, Limits & Triggers

10

Exposure

Risk Profile significantly lower than appetite

Exposure

Exposure

Exposure

Risk Profile is within appetite

Risk Profile is outside appetite

limit

Risk Profile is outside Capacity

Risk Profile approaching

appetite

Limit

Trigger Exposure

Capacity

6. Stress Testing & Business Planning

Capital Stresses

Macro-economic 1 in 20• GDP• Interest rates• House prices• Inflation• Unemployment

Bank specific risks

Liquidity stresses

• Run on the bank• Funding market closure• Wholesale rollovers• Pipeline control failure

6.1 Business Plans and Recovery & Resolution

time

Stress buffer

Recoveryzone

Resolution

Point of Non Viability

Capacity

Limits

Triggers

Target operating range

impact

BusinessPlanrange

StressTesting

7. Critical Success Factors

Top down – Board/CEO

Embed in Strategy/Business Planning

Engage the business heads

Culture

Present / Reinforce

Repeat

7.1 Challenges

Probabilities

Non financial measures

Change

Culture

Business engagement

Q & A

Risk Appetite