Risk Appetite Setting and Modelling Conduct Risk

Peter Mitic

81 percent of firms remain unclear about what it [conduct risk] is and how to deal with it.

This somewhat surprising statement, reported in Thomson Reuters (2015), might cause very severe problems indeed for modelling. Perhaps the statement should be rephrased as “81 percent of firms disagree on what conduct risk is precisely”. In that case, it is easy to state that particular aspects of conduct risk cause problems for the modelling process. In this chapter we examine the origins of those problems, and propose a solution.

As a general guideline, Thomson Reuters (2013) lists, presumably according to the remaining 19%, the principal components of conduct risk. In terms of frequency of response, the most significant five are (in decreasing order of frequency):

• 1. culture;
  2. corporate governance;
  3. conflicts of interest;
  4. reputation;
  5. sales practices.

Of these, all except “reputation” have a bearing on the modelling process. The way they affect models will be discussed in the next section (see Characteristics of Conduct Risk Losses). How conduct affects reputation is the subject of Chapter 11.

What is a conduct risk model?

I