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risk appetite

By Alexander S. Gillis

What is risk appetite?

Risk appetite is the amount of risk an organization or investor is willing to take in pursuit of objectives it deems have value.

Risk appetite can also be described as an organization's risk capacity, or the maximum amount of residual risk it will accept after controls and other measures have been put in place.

Risk tolerance, by contrast, is the amount of deviation from its risk appetite that an organization is willing to accept to achieve a specific objective, based on parameters that include industry and vertical standards.

Organizations can use risk appetite to determine the amount of risk they're taking on in pursuit of their goals. But investors can also use it to determine how much financial gain or loss they're willing to accept. Risk appetite is typically represented by a written document that describes an organization's risk-based decisions. The risk appetite statement is how an organization informs its staff and stakeholders of its risk appetite. Risk appetite is a key part of an effective risk management process.

Factors that influence risk appetite

Risk appetite, an integral component of enterprise risk management, can be influenced by a wide variety of factors:

Risk tolerance is subject to the same factors that determine risk appetite. However, the amount of risk tolerance an organization accepts can vary on a case-by-case basis, depending on factors such as the nature of a project, a project's timeframe and the experience level of the people involved. Risk tolerance can change over time as industry standards, regulations and accepted practices change.

Determining your risk appetite scale

For organizations seeking to determine their risk appetite scale, it's important to consider the probability of a risk and its impact. Once risk probability and impact are used to drive an organization's risk priorities and focus, risk appetite can be evaluated through analysis of the following parameters:

Three types of risks described through tolerance levels are also commonly used when talking about risk appetite for investments: conservative, moderate and aggressive.

Conservative risk deals with anything that carries large amounts of risk. Investors with conservative approaches avoid any potential areas of risk. For an organization, this could be projects with sensitive or mission-critical data and government-contract work. A cautious risk management level is needed for this approach.

Moderate risk has the potential benefits of security measures weighed against the level of risk involved. Investors with a moderate risk tolerance accept some level of risk while specifying an acceptable percentage of losses. This level of risk appetite is adopted by organizations that aren't open to taking many risks and have mitigation strategies in place in case of a disaster.

Those investors that want to risk revenue for the potential of gaining greater profits adopt aggressive risk as a high-risk, high-reward investment. For an organization, this could mean taking on a job that requires a large upfront investment but could provide a large profit upon completion.

Risks can also be thought of as inherent and residual. Inherent risk is the risks taken to achieve an objective, while residual risk is the remaining level of risk after development and implementing the project. Any risks that remain after efforts to identify and eliminate all other risks are considered residual.

How to write a risk appetite statement

Organizations can express their risk appetite by creating a risk appetite statement, a document that helps guide their organizational risk management activities.

This document should ideally include risk-taking approaches, risk mitigation topics as well as implemented and planned risk avoidance measures. The statement should ideally be based on a review of the perspectives and concerns of all stakeholders and address the implications of current corporate strategies and practices, which also means it needs to be updated on a regular basis.

To write a risk appetite statement, do the following:

Examples of risk appetite in practice

Some examples of risk appetite include the following:

Overall, an organization's risk appetite should focus on what the organization is willing to do in pursuit of its objectives, keeping environmental and cultural factors in mind.

Learn more about the differences between risk appetite and risk tolerance.

10 Oct 2023

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