Risk appetite setting is a powerful tool to encourage the taking of risk.
Over the years I have seen risk appetite setting being completed as a process, that supports providing a mechanism to control/limit risk taking. This is not meant to be a negative assessment of risk appetite setting, just an honest assessment of the process.
So, what is an alternative approach to risk appetite?
Risk appetite setting is about clearly defining your “sweet spot” for the business strategy and operations you are delivering. This “sweet spot” is about defining the point you are aspiring to move too, whether that be a growth/increasing position or a contracting/decreasing position.
From there, you can then outline your “operating range”. The “operating range” is about the range of risk you are willing to manage your strategy and operations. The operating range would generally have an upper and lower bound, providing for the appropriate movements in risk taking that occur due to internal and external factors. The operating range, should allow factors that are part of normal business operations or part of expected strategic decisions to occur without exceeding the normal operating range.
The next part of a great risk appetite is setting a “tolerance” level which although you do not want to move within this territory, you are willing to accept a brief entry into the tolerance area(s). However, actions will be taken to move the appetite back within the operating range.
The final part of a great risk appetite, is setting the level(s)/point(s) where you are exceeding your appetite. In these circumstances, you will take immediate action to move back within tolerance and then ultimately into the operating range. In these circumstances, you will also take action on those responsible for exceeding appetite (i.e. there will be consequences) as this is not where the organisation wishes to ever operate.
So, the setting of risk appetite is extremely powerful in ensuring any organisation operates effectively and takes the risk it needs to take to be successful.