Bank of Montreal 2015 Annual Report Download - page 81

MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
Risk Appetite Framework
Our Risk Appetite Framework consists of our Risk Appetite Statement, key risk metrics and corporate policies, standards and guidelines, including the
related limits, concentration levels and controls defined therein. Our risk appetite defines the amount of risk that BMO is willing to assume given our
guiding principles and capital capacity, and thus supports sound business initiatives, appropriate returns and targeted growth. Our risk appetite is
integrated into our strategic and capital planning processes and performance management system. On an annual basis, senior management
recommends our Risk Appetite Statement and key risk metrics to the RMC and the Board of Directors for approval. Our Risk Appetite Statement is
articulated and applied consistently across the enterprise, with key enterprise businesses and entities articulating their own risk appetite statements
within this framework. Among other things, our risk appetite requires:
‰that everything we do is guided by principles of honesty, integrity and respect, as well as high ethical standards;
‰taking only those risks that are transparent, understood, measured, monitored and managed;
‰maintaining strong capital, liquidity and funding positions that meet or exceed regulatory requirements and the expectations of the market;
‰new products and initiatives are subject to rigorous review and approval and new acquisitions must provide a good strategic, financial and cultural
fit, and have a high likelihood of creating value for our shareholders;
‰setting capital limits based on our risk appetite and strategy and having our lines of business optimize risk-adjusted returns within those limits;
‰maintaining a robust recovery framework that enables an effective and efficient response in a severe crisis;
‰using Economic Capital, regulatory capital and stress testing methodologies to understand our risks and guide our risk-return assessments;
‰targeting an investment grade credit rating at a level that allows competitive access to funding;
‰limiting exposure to low-frequency, high-severity events that could jeopardize BMO’s credit ratings, capital position or reputation;
‰incorporating risk measures and risk-adjusted returns into our performance management system and including an assessment of performance
against our risk appetite and return objectives in compensation decisions;
‰maintaining effective policies, procedures, guidelines, compliance standards and controls, training and management that guide the business
practices and risk-taking activities of all employees so that they help optimize risk-adjusted returns and adhere to all legal and regulatory
obligations and thus protect BMO’s reputation; and
‰protecting the assets of BMO and BMO’s clients by maintaining a system of effective limits and strong operational risk controls.
Risk Limits
Our risk limits are shaped by our risk principles, reflect our risk appetite, and inform our business strategies and decisions. In particular, we consider
risk diversification, exposure to loss and risk-adjusted returns when setting limits. These limits are reviewed and approved by the Board of Directors
and/or management committees and include:
‰Credit and Counterparty Risk – limits on group and single-name exposures and material country, industry, and portfolio/product segments;
‰Market Risk – limits on economic value and earnings exposures to stress scenarios;
‰Liquidity and Funding Risk – limits on minimum levels of liquid assets and maximum levels of asset pledging and wholesale funding, as well as
guidelines approved by senior management related to liability diversification, financial condition, and credit and liquidity exposure appetite;
‰Insurance Risk – limits on policy exposure and reinsurance arrangements; and
‰Model Risk – limits on potential capital erosion due to model mis-estimation, data shortcomings, or the use of unvalidated models.
The Board of Directors, after considering recommendations from the RRC and the RMC, annually reviews and approves key risk limits and in turn
delegates them to the CEO. The CEO then delegates more specific authorities to the senior executives of the operating groups (first line of defence),
who are responsible for the management of risk in their respective areas, and the CRO (second line of defence). These delegated authorities allow
the officers to set risk tolerances, approve geographic and industry sector exposure limits within defined parameters, and establish underwriting and
inventory limits for trading and investment banking activities. The criteria whereby these authorities may be further delegated throughout the
organization, as well as the requirements relating to documentation, communication and monitoring of delegated authorities, are set out in corporate
policies and standards.
Risk Identification, Review and Approval
Risk identification is an essential step in recognizing key inherent risks that we face, understanding the potential for loss and then acting to mitigate
these risks. A Risk Register is maintained to comprehensively identify and manage key risks, supporting the implementation of the bank’s Risk
Appetite Framework and assisting in identifying the primary risk categories for which Economic Capital is reported and stress capital consumption is
estimated. Our enterprise and ad-hoc stress testing processes have been developed to assist in identifying and evaluating these risks. Risk review
and approval processes are established based on the nature, size and complexity of the risks involved. Generally, this involves a formal review and
approval by either an individual or a committee, independent of the originator. Delegated authorities and approvals by category are outlined below.
Portfolio transactions – transactions are approved through risk assessment processes for all types of transactions at all levels of the enterprise,
which include operating group recommendations and ERPM approval of credit risk, and transactional and position limits for market risk.
Structured transactions – new structured products and transactions with significant legal, regulatory, accounting, tax or reputation risk are reviewed
by the Reputation Risk Management Committee or the Trading Products Risk Committee, as appropriate.
Investment initiatives – documentation of risk assessments is formalized through our investment spending approval process, which is reviewed and
approved by Corporate Support areas.
New products and services – policies and procedures for the approval of new or modified products and services offered to our customers are
reviewed and approved by Corporate Support areas, as well as by other senior management committees, including the Operational Risk Committee
and Reputation Risk Management Committee, as appropriate.
92 BMO Financial Group 198th Annual Report 2015