Appetite for Risk

February 6th, 2009

How much appetite for risk does an entity have relative to its pursuit of value? Each entity has to develop its own appetite for risk. This will depend on achieving an acceptable balance between growth, risk, and return and creating the proper relationship between risk appetite and strategy.

Effective risk management and execution of strategy requires appropriate alignment of people, processes, and the supporting infrastructure of the organization and process owners. Appetite is linked directly to strategy and is aligned with the desired level of value creation. Different strategic options will evolve based on the assessment of risk attached to each strategy. Therefore, management style and approaches to strategy will drive varying levels of appetite for risk-taking. When setting strategy, entities will vary in their approaches to risk. Qualitative approaches will categorize the entity’s appetite for risk as green, yellow, or red (high, medium, low). Entities that employ a quantitative approach will consider appropriate goals for growth, return, and risk. Risk management helps the management team choose strategies that blend with the organization’s goals for creating value.

There are a number of considerations that impact an organization’s appetite for risk. These factors will vary from business to business. It boils down to what risks the business wants or is willing to accept and what risks they want to avoid. The desired rate of return on initiatives is one of the factors that will influence risk appetite. Risk appetite will be affected by the current rate of return and the competitive need to accelerate growth. The strategic focus of the entity will directly impact whether a company has a high or a low appetite for accepting risk. Risk management needs to consider the organization’s appetite for risk and then guide management in selecting and balancing their decisions in their¬†choice of initiatives and allocation of resources. The tolerance for entity-wide risk will then enter into the selection of objectives in the pursuit of its strategic vision.

Risk tolerance and appetite represents a balance that helps keep businesses and organizations on course and helps to avoid unnecessary and avoidable surprises. It is like walking a tightrope and then deciding how high you are willing to be, in case you fall.