Board Approves AfDB’s Definition of Risk Appetite
Written by Aristide Ahouassou
Effective management of risk is critical to any financial institution’s survival, especially in today’s volatile financial markets and uncertain macroeconomic outlook. The AfDB’s Board approved on May 3, 2011, a policy document on Risk Appetite, which is a cornerstone of the institution’s risk management framework. The document’s approval is in line with the Bank’s vision to safeguard financial integrity and soundness by carefully managing the equilibrium between risk bearing capacity and risks assumed in support of a steady expansion of lending operations. It is also to enable the financial management department pursue its role to strengthen the Bank’s risk bearing capacity and ensure that it is optimally used. Explaining risk appetite, the Financial Management department director, Kodeidja Diallo, said that with the growth in Bank business and in particular non-sovereign operations as well as the increase in the complexity of treasury related activities, risk management was faced with several challenges in ensuring among others, that:
- Capital is sufficient to support risk taking activities to maximize development related objectives of the Bank;
- Individuals who take or manage risks within the Bank clearly understand them and are held accountable for the risks assumed;
- The Bank’s risk exposures are within the limits established by the Board of Directors and /or management, as appropriate;
- Risk decisions are aligned to the Bank’s business strategy and objectives set by the Board; and
- Adequate or reasonable compensation is received for the risks taken.
“The Bank’s risk management framework has evolved significantly over the years. Initially, the Bank’s operational activities focused primarily on sovereign lending with limited low volume non-sovereign (private sector) transactions,” she added.
As the premier development finance institution on the continent, the Bank is frequently called upon to not only increase its lending volume, but also to take riskier exposures that are expected to yield higher development effectiveness and additionality. “The assumption of more risks with a catalytic objective, particularly through increased interventions in the private sector in Africa in general, and in Lower Income Countries (LICs) in particular, is consistent with the Bank’s mandate to mobilize and increase resources for financing development, especially in areas currently considered as being too risky,” Mrs. Diallo further explained. Read her interview.
Interview with Financial Management and Risk Department Director, Kodeidja Diallo
“The definition of Risk appetite statement is a cornerstone of an enterprise-wide risk management framework,” Kodeidja Diallo explained in an interview, following approval of the policy document by the AfDB’s Board on May 3, 2011 in Tunis.
Question: The Board of Directors has just approved the policy document on Risk appetite. Can you explain in simple words what “Risk appetite” means?
Answer: Risk appetite refers to operations whereby the Bank’s risk-taking activities, provide for critical link between the institution’s strategy and day-to-day risk management. The definition of risk appetite is, however, a complex process requiring a careful balancing of different and sometimes even divergent views, perspectives and interests of various stakeholders regarding risks assumed, the use of risk bearing capacity and risk tolerance. To enhance the objectivity of the definition of risk appetite and ensure the inputs of all shareholders, a consulting firm was appointed in September 2010 to assist the Bank in developing a risk appetite statement.
Question: What is the relevance of a Risk Appetite statement for the Bank?
Answer: The Bank always needs to know exactly the level of commitment to remain relevant to its Regional member countries (RMCs) in order to optimize lending operations. The risks taken in the pursuit of the AfDB’s development mandate should neither harm the AAA rating of the Bank nor put it in the position to call for callable capital or ask for further general capital increases before 2020 from RMCs and NRMCs. AfDB risk profile should also be optimized using risk transfer and risk mitigation tools.
Question: How is risk appetite translated in terms of lending?
Answer: Concretely, as an example, the weight of the private sector on AfDB total outstanding portfolio volume will reach ~30% by 2020. This strategy translates into higher loan approvals.