Risk Appetite

Every organisation must take some risk to achieve its goals, but too much risk can lead to serious losses or failure. Risk appetite defines where the balance lies.

Many companies and financial institutions set out their risk appetite in a formal statement approved by the board of directors. This might include limits such as the maximum acceptable loss in a year, the minimum level of capital to be maintained, limits on lending to any single customer or sector, and areas of activity the organisation will avoid entirely.

For example, a bank might state that it has a low appetite for credit risk in unsecured consumer lending and no appetite for breaches of regulations, while accepting moderate risk in lending to established businesses.

Risk appetite differs from risk capacity, which is the maximum risk an organisation can bear before it would fail or breach regulations, and from risk tolerance, which usually refers to acceptable variation around specific targets. For individual investors, the terms are often used more loosely to describe how much risk they are comfortable taking with their money, which, along with their ability to absorb losses, shapes how they should invest.