Often, people use the concepts of risk appetite and risk tolerance interchangeably. However, risk appetite is not the same as risk tolerance. The risk level that an organization can accept per individual risk is risk tolerance. On the other hand, risk appetite is the total risk that the organization can bear in a given risk profile. The risk degree of risk that an organization is willing to consider in pursuit of its objectives before action is deemed acceptable to minimize the risk is the risk appetite. Hence, we can say that risk appetite offers a pragmatic view of risk tolerance.
When we precisely say risk appetite framework, it helps to clearly define your organisation’s risk appetite. It is must to clearly define risk appetite. A clear definition of risk appetite helps an organisation to not only ensure that decisions made throughout a project are strategic but also checks that they in line with the overall objectives.
Risk appetite framework to align strategy and risk
Coming back to risk appetite framework, how it helps any organisation to align their risk management strategies, let us go through in detail.
The linkage between risk appetite statement and risk appetite framework
The risk appetite statement is an expression of the amount and type of risk that the institution is willing to accept in the pursuit of its business. However, the risk appetite framework provides a structured approach to the management, measurement, and control of risk. It is a methodology for organizational people and their processes to ensure that all business activities that they carry out have a striking balance of return for the assumed risk and it remains within the stated or presumed risk appetite limits.
It requires dedicated time, relevant discussion, decision-oriented debate and significant involvement of the key stakeholders to develop a statement of risk appetite.
Creation of risk appetite framework
To create a robust risk appetite process, you should include the following elements:
- The institution’s strategic objectives are articulated by the board of directors and shared with the key stakeholders.
- The chief executive officer serves as the central point of contact between stakeholders and articulates the importance, benefits, and use of the statement of risk appetite.
- The chief risk officer and/or other senior executive or delegates responsible for coordinating the risk appetite process hold a series of focus groups with senior management to ascertain and document the degree of risk they are prepared to accept in pursuit of value.
- In light of economic, competitive and risk outlooks, each and every business line understand and identifies their proposed key initiatives and capital requirements.
- The risk team prepares a comprehensive document articulating the risk appetite framework, identifying and reconciling the key initiatives proposed by the businesses with the top-down corporate strategic objectives, the degree and type of risks taken, and organisational capital capacity.
- The document is discussed with the executive management team, then revised and approved.
- The document is presented to the full board of directors for discussion and approval.
- Once approved, the risk appetite statement is communicated institution-wide, ahead of the budget and planning process and linked to policies and tolerances.
- Businesses are asked to build their plans within the context of the risk appetite statement.
- It is important for a business to review its existing risk policies and limits. This helps them to ensure they are aligned with their risk appetite statement. And, the risk appetite statement is aligned with their strategic goals.
- One should regularly monitor and report risk appetite. Also, on regular basis, it needs to be discussed, for further evaluation, with the board, external stakeholders, including external auditors, regulators, and, potential investors, provided company opts to make public its risk appetite statement.
- Risk reporting is conducted in line with approved and established policies and tolerances. Management reports should routinely include risk appetite measures.
Your risk appetite framework should be well communicated and embraced throughout your organisation. It is not a one-time job. It is an ongoing practice that needs to be taken care of time to time to attain your strategic goals.
Article Provide By: Accume Partners