How Singapore financial firms must utilise risk appetite

Many mismanagement occurrences that happened before and after 2007 led to the 2008 global financial crisis – changing significantly the Singapore corporate-governance landscape.

The monumental failures in risk management, a spate of accounting scandals and outright fraud propelled corporate governance to a new phase driven by a yearning for market discipline, competencies of Boards of Directors, and a culture of ethical conduct and values.

Though it only launched its corporate-governance journey in 2001, Singapore was ranked as the Asian market with the highest standards of corporate governance in 2012, according to the Corporate Governance Watch.

This report was the 9th survey of corporate governance across Asia since 2000, co-produced by CLSA Asia-Pacific Markets (CLSA) – Asia’s leading and longest-running independent brokerage and investment group – and Asian Corporate Governance Association (ACGA).

In the last five years, there has been an increase in regulatory scrutiny and demand for the implementation of profound risk management, finance and governance processes in a bid for more transparency across the region.

In addition, with the many regulatory changes in Asia, there has been an increase in companies performing gap analyses between the companies’ current situations and the future landscape desired by the regulators – driving higher internal standards for governance and risk management.

However, the actions of financial institutions should not be motivated by solely maximising their return. Additionally, they should be driven by the level of the organisation’s risk appetite.

Without this change, confidence in this sector will not be restored and a sustainable future for financial institutions will not be guaranteed.

The industry is aware of the strategic difference, but is only now starting to make the required changes.

Risk appetite reflects the degree in which financial institutions are willing to accept risks when pursuing their objectives and the degree in which they are able to define and manage their willingness to accept risks. Banks, insurers and pension funds have all been dramatically affected by the financial crisis.

Today, they are more than ever convinced of the strategic importance of shaping the risk appetite across their organisations to win back customer confidence.

Recently, CPI Governance, CPI Asia’s parent company, led a study sent to 500 directors and supervisory directors of banks, insurance companies and pension funds with the objective of defining and analysing their vision on risk appetite, to determine insights into how much each respondent accepts risk when pursuing objectives and whether that risk appetite is controlled within agreed-upon tolerance levels.

The study also set out to define and analyse relevant trends and address the relationships between risk appetite, the mission/identity and the strategy of these financial organisations.

The survey comprised both quantitative and qualitative aspects and garnered response from 78 executives, equally divided over the three sectors. Three quarters of the respondents agree with the strategic importance of shaping risk appetite and believe the following must happen to improve their organisation’s trust with key stakeholders:

Increase risk awareness across the organisation
Adopt better strategic planning risk-oriented processes and procedures
Support decisions related to capital allocation and risk

If banks, insurers and pension funds want to secure their sustainable future, they have to shape risk appetite by combining 'hard' measures with a change in behaviour and culture, whilst linking their risk appetite to their strategy and social objectives.

Industry-leading organisations are making progress in introducing 'hard' measures. This involves adapting to internal governance structures and organising 'countervailing powers', with the intention to balance risks and returns.

It is critical to reorganise remuneration incentives since more than 70 per cent of the study’s respondents think that there is room to improve remuneration incentives by correcting the financial performance as part of the remuneration policy for estimated risks and costs of capital.

Finally, risk appetite must be embedded into decision-making processes through specified risk tolerances and limits, and by controlling these processes.

At present, the industry forerunners are focused on applying the above-mentioned measures more deeply throughout their organisations under the scrutiny of the management board.

Though driving and realising a change in behaviour and culture and knowledge development is even more vital for financial institutions then the ‘harder’ measures, less progress with these 'soft' measures is still typical.

Almost 60 per cent of the respondents state that risk appetite is not discussed with sufficient depth in meetings between the management board and the supervisory board.

On average, 45 per cent of the respondents think that there still is insufficient knowledge within these bodies to conduct discussions with sufficient depth on risk profile, capital allocation and liquidity issues.

Supervisory directors think that they themselves should pay more attention to the necessary change in culture and behaviour and want to see this placed on the agenda more often. They also think that external supervisors should focus more on behavioural issues in order to increase the pressure on the change process.

A number of prominent leaders in the financial sector realise that it is necessary to link risk appetite to the strategic and social objectives to build a strong reputation. They are leading the charge in the race to establish a link with the social function of the financial institution.

Future successful financial institutions will broaden their shareholder’s philosophy to a stakeholder’s philosophy. They will explicitly consider the interests of all stakeholders and communicate this in an effective way.

Instead of focusing solely on returns, the spotlight will be increasingly on risk appetite as the foundation for broader stakeholder interests. At the same time, external supervisors should focus more on the behavioural aspects in order to increase the pressure on the change process.