Part three in a three part series by Dr David Hillson and Ian Huntly, CEO of Rifle-Shot Performance Holdings
The RARA Model indicates how we can exercise control over setting risk thresholds to make sure that they are appropriate in the setting of the given situation, taking account of the influence of individual risk preferences as well as of organisational risk culture, and ensuring that the risk thresholds do not exceed our risk capacity.
We have already seen that the influences on risk appetite are internal and so cannot be easily modified or measured. However risk attitude is a choice and it is possible to choose a different risk attitude. As a result, the ability to choose a different risk attitude in a given situation provides a point of control in the RARA Model.
We can now take a four-step approach to setting appropriate risk thresholds:
* Unmanaged – first we set risk thresholds intuitively without any conscious intervention or modification. This will result in risk thresholds that reflect the internal risk appetite.
However since all the factors influencing risk appetite are internal and cannot be modified, the resulting risk thresholds may be inappropriate. Because these initial risk thresholds are set using “gut feel”, the effect of chosen risk attitude is excluded at this point.
* Constrained – the initial risk thresholds are reviewed in the light of the individual risk propensities of the decision-makers, as well as considering the organisational risk culture.
* Check – at this point we should review the risk thresholds against the risk capacity to determine whether they are appropriate. If not then some intervention is required.
* Informed – the final step is taken if Step 3 indicates the need to modify the risk thresholds. This takes advantage of our ability to choose a different risk attitude, and uses it as a point of active and intentional control in the process. By changing our risk attitude we are able to influence the final choice of risk thresholds to produce something that is more appropriate.
This simple four-step process provides us with a simple and practical way to set risk thresholds at a level that will enable us to take the right risks safely.
Conclusions
Risk is inevitable in business to survive and grow, and selecting which risks are manageable is a key element of a thriving company.
Risk appetite matters. It is an important topic for us to understand, because our risk appetite drives the way we answer the important “How much risk…?” questions. But risk appetite is an internal tendency, invisible and impossible to measure. As a result we need to use an external proxy to allow risk appetite to be expressed and this is the role of risk thresholds.
Unfortunately the internal nature of risk appetite also means that if it is left unmanaged it might result in the setting of inappropriate risk thresholds, leading us to take too much or too little risk. We therefore need a way to intervene and modify risk thresholds that have been set intuitively using the gut-level risk appetite.
Intervention is possible by choosing a suitable risk attitude that allows us to modify the initial risk thresholds, moderating the effect of unmanaged risk appetite. The RARA Model combines both risk appetite and risk attitude, providing a practical way for decision-makers at all levels to answer the “How much risk…?” questions, and take the right risks safely.