The Power of Risk Appetite

Risk appetite setting is a powerful tool to encourage the taking of risk.

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Risk appetite setting is a powerful tool to encourage the taking of risk.

Historically risk appetite setting has been completed as a process that occurs to reduce risk taking. This is not a negative assessment, just an honest assessment of the process.

What is an alternative approach?

Deloitte outline in “Risk appetite frameworks – How to spot the genuine article” that,

Everyone these days seems to agree that risk appetite frameworks are good things – even if no-one can quite agree what a good one looks like.

Simple Steps for Risk Appetite

In the alternative approach there are 4 simple steps to setting risk appetite:

  1. “Sweet Spot”
  2. Operating range
  3. Tolerance
  4. Exceeding

“Sweet Spot”

Firstly, we must define the “sweet spot” for the business strategy and operations we are delivering. This “sweet spot” defines the point we are aspiring to move to; whether that is a growth/increasing position or a contracting/decreasing position.

For example, our posting on Agile Risk Management outlines the importance of undertaking shorter sprints of activity. This requires us to critically assess our approach to the right sweet spot for risks in each sprint.

Operating Range

Once you have established the “sweet spot” we must outline our “operating range”. The “operating range” is the range of risk we are willing to take to execute to our strategy and operational outcomes. This range will have an upper and lower bound, providing for movements in risk taking due to internal and external factors. A good operating range allows factors that are part of normal business operations and part of expected strategic decisions to occur, without exceeding your normal expectations.

Tolerance

The third step is then to set a “tolerance” level, which although we do not want to move within this territory, we are willing to accept a brief entry. When in the tolerance level actions must be taken to move back within the operating range.

Exceeding

The final step is to set the level(s) where we are exceeding our appetite. In these circumstances, we will take immediate action to move back within tolerance and the operating range. In these circumstances there must be consequence management on those responsible for exceeding appetite (i.e. some form of “cost” of exceeding appetite, including training, coaching, and/or potential financial penalty).

These simple steps provide a template for understanding, documenting and monitoring your appetite settings.

In Summary

The setting of risk appetite is powerful in ensuring organisations operate effectively and take the risk needed to be successful.