The Liquidity Risk Management Guide: From Policy to Pitfalls

7 Step II: Risk Appetite

Now that the risk assessment has been concluded the risk specialist should have an overview of what kind of liquidity risk is material, what the funding profile of the bank is, etc. The next step is to formulate a high-level liquidity risk appetite statement. One might argue that setting the risk appetite should happen first, before the bank starts its operations and accepts liquidity risk. That would be the case if we were starting up a bank, but the reality is that the banks came first and risk management was introduced much later.

7.1 THE RISK APPETITE STATEMENT

A risk appetite statement is the overall ‘mission statement’ for liquidity and funding. The aspect we are concerned about here is the ‘micro’ angle focusing on an individual bank. If one subscribes to the view that the appetite for risk goes in cycles, then the liquidity risk appetite can also play a ‘macro’ role in creating liquidity cycles that can pose threats to the financial stability. Benoît Cœuré, Member of the Executive Board of the ECB, pointed out how the increased appetite for liquidity risk eats up liquidity and creates at the end a liquidity shortage, which in turn decreases risk appetite. Benoît calls them ‘global liquidity cycles’, where liquidity fluctuation exacerbates the underlying weaknesses in the economies.¹ This is a valid observation but for this book we limit ourselves to a single bank.

7.1.1 Eggs, Omelettes and a Free Lunch in the Board Room

The risk appetite ...