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Getting Practical on Risk Appetite and Risk Tolerance
December 2011 Bonus Resource
Over the past year, I’ve helped many management teams and boards get clarity about the concepts of risk appetite and risk tolerance. They came to me because, although there is a lot of chatter on the topics of risk appetite and tolerance, much of the literature is so jargon-filled that it’s a struggle to find the practical application of the concept.
Over the summer Melanie Herman, Executive Director of the Nonprofit Risk Management Center, invited me to co-author a white paper* with her on the topic of risk appetite. I jumped on the opportunity to distill my practical experience into a simple process that any organization can use to articulate its risk appetite and effectively integrate it in their decision-making. Here are the 5 steps of the process:
There is only room to provide details on part of the approach in this article, so I’ve chosen to share the first step in the risk appetite articulation process because it is essential for correctly framing the risk appetite discussion by the executive team and the Board.
Defining the parameters or principles for risk-taking involves reflecting on the organization’s mission and its corporate strategies aimed at achieving that mission. For example, a nonprofit whose mission is to help low-income residents of a rural community may decide its core strategy is to work through existing social services agencies rather than serve clients directly. An innovative partnership with a new agency would be mission and strategy-consistent. An innovative program to deliver services directly (eliminating the “middle-man”) would not.
Here are a few questions that you can use to define your organization’s parameters for risk-taking:
For example:
Employees and managers need to understand the organization’s parameters for risk-taking to ensure that their decisions lead to the most efficient and effective use of resources and balance potential upside and downside effects. In the absence of a clear statement of risk appetite, it is left to each manager and employee to infer what he or she believes is the organization’s risk appetite. Invariably this leads to inconsistent risk taking and situations where risk is either under- or over-managed. Either case can result in sub-optimal organizational performance and resilience.
* The complete white paper (including a more detailed explanation of how-to articulate and apply a risk appetite and risk tolerance framework) is available in the second edition of Ready… or Not: A Risk Management Guide for Nonprofit Executives.
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