Risk is an integral component of any business project. In its turn, risk appetite is a concept in the practice of risk management, which is difficult to define. However, it is necessary to assess the risk appetite of a company to provide effective planning of its activities and improve general performance. The current paper analyses the concept of risk appetite and its practical use, as well as methods for determining the company’s risk appetite and approaches to risk assessment.
Defining Risk Appetite and its Practical Application
Risk appetite is a crucial component of the risk management process. It can be defined as “the immediate or short-term willingness of an organization to undertake an activity that involves risk” (Hopkin, 2017, p. 302). Risk appetite can be assessed with the help of risk criteria that usually depend on the organization. One of the problems associated with risk appetite is that, in fact, organizations have to risk to continue specific activities, start new projects, or implement innovative strategies rather than have an appetite for the risk itself.
Risk appetite is related to the enterprise risk management framework as well as risk tolerance and risk culture, which determine the reputation of the company (Lam, 2015). Moreover, risk preference and risk propensity should be considered in the context of the risk appetite (Hillson & Murray-Webster, 2017). The practical application of the risk appetite comprises such activities as the definition of principles for risk-taking specific for every organization, calibration of the risk appetite to prevent thoughtless business decisions, change in the company’s risk culture to meet the risk appetite, the use of risk appetite for risk assessment, and regular revision of the risk appetite statements to ensure their applicability in current conditions.
Methods for Determining the Risk Appetite of a Company
One of the methods to determine the risk appetite of a company is to develop the risk appetite statements. They will depend on the strategy applied within a company. Therefore, risk statements for high and modest risk appetite will be different (Hopkin, 2017). The development of these statements comprises such stages as the identification of the involved stakeholders, determination of the whole-company risk exposure, establishment of the desired levels of risk exposure, reconciliation of the risk appetite and tolerances as well as planning actions to bring together risk exposure and appetite (Hopkin, 2017). Finally, the determined risk appetite statement should be ratified and communicated to stakeholders.
The Process and Approach to Risk Assessment
The risk assessment is one of the components of the risk management process, together with risk recognition and risk rating. Several approaches can be applied to the process of risk assessment depending on the stakeholders involved (Hopkin, 2017). The major approaches include top-down risk assessment when it is conducted by senior managers and directors and bottom-up risk assessment provided by the employees. Both approaches have advantages and disadvantages. Thus, top-down risk assessment allows capturing the most critical risks and is usually consistent, although it is characterized by the lack of attention to internal risks (Hopkin, 2017).
At the same time, bottom-up risk assessment provides an overview of local organizational risks. Another benefit of this approach is its flexibility, which is useful for multinational corporations. However, this approach lacks insight into external risks.
On the whole, risk appetite is a significant part of the company’s risk management strategy. Since risk is an integral component of any business, it is essential to determine the risk appetite and integrate it into the risk management interventions of the company. After all, it is necessary to conduct a regular risk assessment to regulate the strategies applied by the company and prevent unreasonable risks that are harmful to the company’s reputation and general performance.
Hillson, D., & Murray-Webster, R. (2017). A short guide to risk appetite. Farnham, England: Gower Publishing Limited.
Hopkin, P. (2017). Fundamentals of risk management: Understanding, evaluating, and implementing effective risk management (4th ed.). New York, NY: Kogan Page Limited.
Lam, J. (2015). Implementing an effective risk appetite. Montvale, NJ: Institute of Management Accountants.