Your article Hows your risk appetite? (bit.ly/2MwlphA) rightly draws attention to the importance of defining clear, relevant and practical risk appetites before undertaking risk management.
Your article How's your risk appetite? (bit.ly/2MwlphA) rightly draws attention to the importance of defining clear, relevant and practical risk appetites before undertaking risk management.However, it is disappointing that the article does not mention the linked subject of risk tolerance. Whereas risk appetite is the degree of risk which the firm is willing to take, risk tolerance is the degree of risk which the firm is able to take without getting into serious difficulties if foreseeable adverse scenarios actually occur.
If the firm's overall risk appetite exceeds its risk tolerance, there is the possibility of high profits but also of enormous losses or even insolvency. If its risk appetite is less than its risk tolerance, the firm will be relatively stable in a wide range of circumstances, but may not be as profitable as a competitor that is willing to take somewhat higher risks. It is the board's responsibility to understand the difference between the two concepts before deciding on its overall risk appetite.
Chris Lewin
13 June 2018
