By Laura Sullivan, Board and Governance Specialist
Organisations are increasingly being asked by stakeholders and regulators to articulate the amount and nature of risk they will seek and accept in achieving their objectives.
In its simplest form, this is risk appetite; an indication from the board of what risks are prudent to take for value creation and the extent of exposure that can be managed by the organisation.
Even if not consciously recognised as risk appetite, in developing a strategic plan and making decisions on matters such as investments and entering into major contracts, a board is implicitly defining its risk appetite.
Risk appetite is distinct from risk capacity (the amount of exposure an organisation can withstand) and risk tolerance (the amount of exposure an organisation is willing to bear) in that it specifies the amount and type of risk an organisation will take in meetings its strategic objectives, providing a balanced approach to risk and reward.
What is a Risk Appetite Statement?
A Risk Appetite Statement (RAS) is a written definition of risk appetite that specifies the amount and type of risk an organisation is willing to take in meeting its strategic objectives.
Defined by the board, an organisation’s RAS should align with its purpose and strategy and consider the risk appetite of key stakeholders. In this manner the RAS serves as a central strategy document.
By having an explicit discussion about risk appetite – and recording that in a pragmatic and lived RAS – the board can ensure that there is collective alignment on matters such as its growth ambition, how much debt the company is willing to incur, where it will operate, and its attitude to compliance.
In turn, the RAS provides a forum for mutual understanding between the board and management of the acceptable approach to strategy and its delivery.
Why is a Risk Appetite Statement important?
The RAS provides the basis for the risk management framework of the organisation. Essential for boards in delivering on their responsibilities for risk oversight, a well-defined RAS:
- evaluates strategic risk and opportunity across the value chain of an organisation
- enables management in operationalising risk management through appropriate policies and procedures
- supports decision making by directors, management, and throughout the organisation
- informs the desired risk culture by defining acceptable language, behaviours and action, and
- empowers proactive monitoring of risk and opportunity throughout the organisation; ultimately making risk management everyone’s responsibility.
Board considerations
Risk appetite is not a single fixed concept, and there are a range of appetites across the value chain of any organisation for different risks. It is useful for boards to consider their risk appetite across all relevant areas with the following considerations:
- understanding of the relationship between risk and reward; such that opportunity capture is considered alongside risks with negative consequence, and
- the board’s role in strategic risks, namely, those risks relevant to the strategy, purpose and goals of the organisation including long term, external or emerging issues, or with significant financial impact.
Actions for your board.
Risk appetite can be complex. It is often challenging for boards to articulate and measure, although the risk appetite conversation alone is as valuable as the artefact of the RAS. The following are recommended actions for your board in developing a RAS.
- Identify the strategic risk categories that are critical to your organisation
- Define the appetite scale which you will use to define your RAS
- Identify your strategic risks
- Assess your risk appetite with statements of intent in each risk area
- Where possible, provide specific measures of success (or Key Risk Indicators) for each risk or risk category
- Integrate the RAS with your risk management framework
- Review and update
Often boards will develop a simple RAS and mature that document each year. Further, as an organisation changes and matures, its risk appetite in particular areas may also change.
Risk appetite can be a complex matter, however when clearly defined it becomes an effective tool for board oversight of risk.
Directors Australia facilitates board risk workshops including risk appetite, strategic risk identification and board reporting across all market sectors and in
dustries.
