Transcript
NARRATOR:
There are risks you want to take and risk you don't want to take, risks you cannot afford to take, and risks you cannot afford not to take. Risk appetite defines the level and types of risks that you're prepared to take in order to achieve your strategy. The aim for companies not to remove all risks but to ensure that the level of risk being taken is appropriate given the level of return being received, they are aiming to operate in their desired risk-or-return sweet spot.
Companies will typically start by understanding their maximum amount of risk that they are prepared to take. This is called their capacity. They will then set their appetite at a level below their risk capacity.
It is good practise to have trigger levels to give early warning signs if too much or too little risk is being taken. The company will then assess its current risk profile against their risk appetite and capacity. Let's look at an example of this.
Risk lower than capacity, more risk can be taken to increase returns. Risk between triggers, this is the desired range or sweet spot for risk taking and reward. Risk in appetite but above upper trigger. Level of risk would be escalated so that the action can be taken to reduce the risk level before appetite is exceeded.
Risk above appetite level. Immediate action needed to reduce the risk level. Risk above capacity. The firm is not viable. The level of risk exceeds the firm's capacity to absorb the risks. This clearly sets out the targets and measures and allows companies to take appropriate steps so that they can take their desired level of risk.