A constant struggle for the risk manager of an organization is balancing the profitability expectations of its shareholders and maximizing operational efficiency of the risk management team in order to reduce the organization’s Total Cost of Risk (TCoR). Having a clear perspective of the organization’s appetite for risk and risk tolerance is a fundamental element needed in order to achieve this balance.
The difference between risk appetite and risk tolerance is that risk tolerance is the maximum risk that a company can reasonably assume. Risk appetite, on the other hand, is the amount of risk that the company actually assumes based on their own comfort levels. The organization’s balance sheet is a great place to start to evaluate the levels of risk it is willing to retain.
Determining the risk appetite and risk tolerance levels is a fundamental aspect of developing an effective risk management plan. Having a strategic risk appetite and risk tolerance policy in place often provides consistencies in an organization’s risk-taking activities and helps the risk manager balance expectations. Therefore, it helps set guidelines for the risk manager and establishes a framework that encompasses these strategies.
An independent risk management consultant can help manage this process and work with your finance and human resources team to establish a framework that meets your overall risk management strategy.
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