Some interesting words from the head of APRA on the wider universe of risks that the prudential regulator is starting to focus on:
"As the prudential supervisor, we need to make sure that we do not have a Maginôt Line, but flexible defences that address the different types of risk that can accompany a strongly growing economy — risks of over-confidence, of poor strategic decision-making, of eyes ‘off the ball’ on credit standards and risk management generally...
A particular focus of our enhanced engagement with boards will be risk appetite. At the heart of a good risk management framework is a clearly articulated statement of the board’s appetite for risk. From this can flow the myriad of policies, procedures, limits, reporting and other internal control and assurance mechanisms that make up the entirety of a risk management framework in a financial institution. In contrast to the general and life insurance industries, APRA’s prudential standards for ADIs do not yet require a formal board risk appetite statement but a risk management standard containing this requirement is being developed.
Looking ahead to that standard, APRA has been reviewing the risk appetite statements of many of our regulated institutions to help us identify good practice. Not surprisingly, we have found a wide range of practices — some risk appetite statements are quite short while others go for many pages; some are very quantitative while others are more qualitative in nature; some are enterprise-wide in their scope while other are narrowly focussed on business lines or risk types. APRA does not have a particular template in mind. Rather, as a principles-based prudential supervisor, our interest is in how well the risk appetite statement fulfils its purpose, in conveying clearly and concisely the Board’s preferences and risk tolerances to the rest of the institution.
A second aspect of our supervisory approach that we want to reinforce relates to our capabilities for assessing business models and product lines...
Supervisors by their nature tend to focus on areas where there are signs of trouble. One obvious warning sign is a poorly performing business line, where there is a danger that management will attempt to improve profitability by assuming more risk. Supervisors are generally alert to such dangers. However, the crisis has highlighted that apparently well-performing business lines can send misleading positive signs because underlying risks are being underestimated. Fast growing loan books are one example; another example — fortunately only limited in Australia — was the apparently high risk-adjusted returns on structured credit portfolios that proved in the end to be illusory, since risks were not well understood or measured."
