Part one in a three part series by Dr David Hillson and Ian Huntly, CEO of Rifle-Shot Performance Holdings.

One of the most important decisions for any business, project or individual is how much risk to take, given the maxim that low risk almost inevitably means little or no growth (in itself a risk) and high growth driven through smart risk taking.

The phrase “risk appetite” is often used to describe the level of acceptable risk, but there is no accepted definition for this term. Even worse, there is confusion between risk appetite and other risk-related terms, especially risk attitude.

In seeking to answer the “How much risk…?” question, Dr David Hillson and Ian Huntly, CEO of Rifle-Shot Performance Holdings, consider a range of risk terms, showing how they relate to one another.

This reveals that two risk-related factors are particularly influential when individuals or organisations decide how much risk can be taken in a risky and important situation. These two key factors are risk appetite and risk attitude, which have central and complementary roles.

Risk appetite is an internal tendency to take risk in a given situation and it reflects organisational risk culture and the individual risk propensities of key stakeholders.

But unmanaged risk appetite can lead to disastrous outcomes. Risk attitude is a chosen response to risk, driven by perception, and it can act as a control point to ensure that the right amount of risk is taken, so that the achievement of objectives is optimised.

Putting both risk appetite and risk attitude together into a single framework (the RARA Model) provides a practical approach that enables individuals and organisations to take the right risks safely.

Recent research on risk appetite (Association of Insurance and Risk Managers, 2009) has identified four ways in which an understanding and expression of risk appetite can be used within organisations:
* To support strategy-setting, leading to a balanced risk profile and identification of which risks to avoid and which to take;
* To support effective management of risk, by ensuring that risk management resources are allocated optimally, and fostering a risk-aware culture across the organisation;
* To set appropriate boundaries for risk-taking, by motivating decision-makers to make better and more consistent decisions; and
* To maximise stakeholder value, by enhancing organisational performance and delivery.

What is appetite?
For most people, the word appetite is closely linked with being physically hungry.

Appetite is not the same as hunger. Appetite is a desire, a psychological need that demands to be met. The external expression of appetite is hunger, which we experience as a lack of something and which motivates our behaviour in an attempt to satisfy the internal desire.

What is risk appetite?
Risk appetite is then expressed using risk thresholds, which are described against objectives, and which can be measured externally.

Why does risk appetite matter?
Risk appetite matters for two key reasons. The first is that it is increasingly becoming a compliance requirement, driven by international risk standards, corporate governance regulations and others.

But secondly and more importantly, the ability to understand and express risk appetite allows decision-makers at all levels in an organisation to decide how much risk they should take in a given situation, from board-room to project teams.

For each of these important management decisions, risk appetite drives the answer to the question “How much risk should we take?”

As a result it is important for managers at all levels to understand and express their risk appetite, from the CEO to the project manager, and for these multiple levels of risk appetite to be consistent, coherent and aligned.