National authorities have made progress in improving regulatory and supervisory oversight of risk governance at financial institutions (FIs) since the 2008 financial crisis, but further work is needed says the Financial Stability Board (FSB).
The FSB, which is chaired by Bank of Canada (BoC) governor and governor-designate of the Bank of England (BoE), Mark Carney, and hosted by the Bank for International Settlements (BIS) has published a thematic peer review on risk governance. It examines risk governance practices at national authorities and firms, assesses progress made since the crisis, identifies sound practices and offers recommendations to support further improvements.
The Basel, Switzerland-based institution reports that the crisis exposed various risk governance weaknesses in major FIs, relating to the roles and responsibilities of corporate boards of directors the firm-wide risk management function, and the independent assessment of risk governance. Without the appropriate checks and balances provided by the board and these functions, a culture of excessive risk-taking and leverage was allowed to permeate in many firms.
The peer review found that, since the crisis, national authorities have taken several measures to improve regulatory and supervisory oversight of risk governance at FIs, such as developing or strengthening existing regulation or guidance, raising supervisory expectations for the risk management function, engaging more frequently with the board and management, and assessing the accuracy and usefulness of information provided to the board to enable effective discharge of their responsibilities.
However, the FSB concludes that more work is necessary. In particular, national authorities need to better assess the effectiveness of a firm’s risk governance framework, and more specifically its risk culture, to help ensure the sound management of risk through the economic cycle. Supervisors will need to strengthen their assessment of risk governance frameworks to encompass an integrated view across all aspects of the framework.
The peer review also surveyed 36 banks and broker-dealers that FSB members deemed as significant for the purpose of the review. The evaluation of their responses indicates that many of the best risk governance practices at surveyed firms are now more advanced than national supervisory guidance, an outcome that may have been motivated by firms’ need to regain market confidence.
Despite these considerable strides, significant gaps remain in a number of areas, particularly in the risk management function. At the core of strong risk management is an effective risk appetite framework, and firms’ progress to date is uneven in its development, comprehensiveness and implementation. Very few firms were able to identify clear examples of how they used their risk appetite framework in strategic decision-making processes.
Drawing from the findings of the review, the report identifies a list of sound risk governance practices that would help firms continue to improve their risk governance and national authorities to assess its effectiveness. The review also sets out several recommendations targeting areas where more substantial work is needed, in particular:
- National authorities should strengthen their regulatory and supervisory guidance for FIs and devote adequate resources to assess the effectiveness of risk governance frameworks.
- Standard-setting bodies should review their principles for governance, taking into consideration the sound risk governance practices set out in the report.
- The FSB should explore ways to formally assess risk culture at FIs.
- The FSB should provide general guidance on the key elements that should be included in risk appetite frameworks and establish a common nomenclature for terms used in risk appetite statements.
“The review usefully pulls together good risk governance practices and identifies follow-up work that needs to be done by national authorities to strengthen their ability to assess the effectiveness of firms’ risk governance frameworks,” said Tiff Macklem, chairman of the FSB’s standing committee on standards implementation (SCSI). “Recent headline events surrounding activities at some large FIs underscore the importance of promoting and implementing a sound risk culture.”
Swee Lian Teo, chair of the peer review team on risk governance, said “While measures have been taken to improve risk governance, the review showed that there are still gaps that needto be addressed by both firms and supervisors. The report sets out recommendations that will help supervisors everywhere raise the bar on their expectations for risk governance so that firms’ practices continue to improve through changing environments.”
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