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Risk Appetite and Tolerance

Question:

Produce a document on: Risk appetite: present the concept and discuss the current practices.

Answer:

What is risk appetite?

It is imperative to define risk appetite with the same set of words as many experts do not accept the BS31100 definition which states, the quantity of risk which an organization is prepared to accept, tolerate and seek is called risk appetite”. Few other definitions state it as the risk which an entity will indulge in for achieving its goal. As per KPMG, it is the quantity of risk which an organization is willing to retain or accept in order to attain certain value.

Hence, it is clear that no single definition can define risk appetite.

Role of risk appetite in risk management

The risk appetite should definitely aid the risk management plan of the firm. An organization should know its appetite for risks in order to allocate its limited resources in a proper manner. Effective communication of risk appetite not only helps in classifying the appetite of a farm, it also helps in evading the risks which are outside the appetites limit.

Limiting the risk taking boundaries

Setting up boundaries for risk taking helps an organization to maintain the corporate governance. Some of the benefits of having clear appetite are:-

  1. Limiting the organizations from taking too much risks and loosing assets.
  2. Limiting the conservative actions of an organization which might result in lower return from its own activities.

Value maximization

It is really essential for organization to take care of the stakeholders’ expectations and more essential when the resources are limited. Risk appetite comes in handy for analysing this and measures the risks which can be taken by the various stakeholders.

Risk appetite helps the firms in understanding various appetites/limit of different stakeholders & maintains good balance between all of them, keeping all of them happy. 

Emerging views of good practices

This section will provide few of the good practices for risk appetite:-

 

Top down

Bottom up

Descriptions

It is created by the management and is cascaded in the firms

At the ground level, risk appetite are believed to be made for overall appetite for a certain risk

Positives

Board is in the best position for resolving disputes between stakeholders.

It takes help of the local risk experts for arriving a perfect view of risk’s appetite.

Negatives

Can be imposed even if it wrong by the boards members

The local views can at times not be so helpful as you would like it

  1. Analysing the strategic operations and objectives of the business.
  2. Expression of appetite for both longer and shorter runs
  3. Emphatic communication and presence of clarity for presenting the idea in front of employees.
  4. Embedding appetite for risk in to the decision making process of management

What is Risk Tolerance?

It can be termed as the volume or number of risks which a particular organization can take without causing any hindrances to their strategic plans. This risk tolerance can be of two types ranging from an overall risk tolerance to the one which is limited to certain unit of their business. Risk tolerance is company’s capacity to sustain a risk after risk treatment has been executed for achieving the objectives of the company. It is represented or commuted within the organization and employees in the manner of acceptable results, unacceptable results and also as limited risk levels. The risk tolerance statements clearly benchmark certain limits beyond which (both maximum and minimum) companies do not wish to operate and lose more of its assets due to higher levels of risk (Martens, 2012). 

References

Crickette, G., Demian, R., Fox, C., Hach, J., Manager, R., Electric, L., … Arbasetti, K. (2012). The risk perspective exploring risk appetite and risk tolerance. 

Protiviti. (2012). Defining risk appetite early mover series: Integrating corporate performance management and risk management 1 PRotIvItI early mover series: 

Rittenberg, L., & Martens, F. (2012). Thought leadership in ERM | enterprise risk management — understanding and communicating risk appetite | 3 understanding and communicating risk appetite. 

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