DETERMINING RISK "APPETITE"

 Determining Risk “Appetite”

• The board of directors has the primary oversight responsibility for developing and implementing the organization’s mission, values, strategy, and must carefully review corporate processes of risk identification, monitoring, and management. The board also originates risk philosophy, risk appetite, and risk tolerances. 
• Specific reviews of financial objectives, plans, major capital expenditures, and other significant material transactions also typically fall within a board’s responsibility. These responsibilities require broad and transparent reporting on the various organizational risks—strategic, operational, reporting, and compliance risks. 
• When the Board sets the organisation’s vision, strategy, goals and targets into motion it is aware of the potential business risks the organisation is exposed to and thereby can broadly estimate the extent of potential losses that the business shall be exposed to in the event the plans and management actions don’t bear the desired fruits.
•  Risk capacity is the overall ability and financial boundary within which the Board can play their business bets; whereas Risk Appetite is the hard stop limit within which the Board would like to restrict its business actions. 
• For example an entity with a networth of ` 500 Crores may have a capacity of risk taking upto ` 500 Crores while the Board may still articulate a philosophy that the risk appetite of the entity would be limited to ` 100 Crores only or upto 20% of the networth of the entity. On account of such policy statement on the risk appetite, the Business managers would not be allowed to take decisions that have the potential to go beyond the risk appetite limits of the entity. Therefore, Business managers would have to drop choices that have the potential to impair the financial stability of the company beyond the boundary set up by the Board. 

In determining the risk appetite of the company, the Board should engage with the executive/ management team and provide clear directions on the contours and definition of the risk capacity, appetite and tolerance levels. For example, when does a company become uncomfortable if the percentage of its revenues generated by just top four or five clients rises continually or even becomes dominant? Another example ‘___’ company which experiences 10% growth (and still growing) in product returns from customers. At what point does this become too big a risk to overall customer satisfaction, company costs or general reputation? In both of these cases, one company may have a completely different tolerance of risk to another but this needs to be explicitly understood and capable of change when circumstances require it to do so. 

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