Are the risks taken by banks socially responsible?

The definition of risky behaviour is not always easy. It is a fact that every financial institution will aim for some return so that it will be able to perform its services fully and to achieve sustainable growth. The higher it aims in respect of return, the more risks it will have to take. 

The attention for efficient risk management has increased steadily since 2008. In the first place because the regulations for and the control of risk management have become much stricter. Since the implementation, in 2006, of the Basel II agreement on capital requirements for financial institutions, the supervisors have paid increasingly more attention to the risk profile or the so-called risk appetite of lending institutions and investment firms. They are trying to map out the risk profile of an institution carefully and to raise the quality of the risk management.

The National Bank of Belgium (NBB), one of both Belgian supervisory authorities, has developed a range of instruments for this. There is, for example, the Internal Capital Adequacy Assessment Process or ICAAP where every institution must work out an internal capital assessment process and must lay down capital targets that correspond with its risk profile and the quality of its internal control. This internal control is in the hands of the effective management of a bank or investment firm. They must report their assessment of the internal control to the NBB.

In the last few years, the financial institutions have heavily invested in better risk management, tighter internal control and better reporting.

The number of staff in the Risk department, which identifies, assesses and manages risks, rose by a quarter (24%) between 2008 and 2011. The number of people in Compliance, the department that ensures that all rules are respected within the institution, even increased by 70%. Only in the Audit department, which is responsible for ex post control, the number of effective employees dropped by 15%. The total staff in the three departments rose at the four large banks from 978 in 2008 to 1,178 in 2011, an increase of 21%. These figures show that the institutions have chosen in full awareness to place more focus on prevention instead of control after the facts and that they are heavily investing in it.

What is risky behaviour?

The definition of risky behaviour is not always easy to determine. Which policy can be described as risky and which not? Before 2007, the illusion existed that zero risk was possible, for loans to governmental bodies for instance. The events of the past few years, however, have shown that investments that were described as safe and non-risk can also carry a risk.

Due to the financial crisis, the financial institutions are paying more attention to the quality of their risk management to prevent the same problems from occurring again.

More than half of the sector (54% or 7 of the 19 surveyed institutions) no longer sets targets based on Return on Equity, and 38% (6 of the 19 surveyed institutions) sets targets of over 12%. This target is strongly dictated by the international character of the Belgian financial sector. 82% of the institutions have their headquarters abroad and therefore feel more pressure from the financial markets and their foreign shareholders to achieve a higher return. It is obvious that the higher the return target, the higher the likelihood that more risk will be taken to achieve this return.