Risk Appetite as a Core Element of ERM: Definition and Process

Risk appetite represents how much risk an organization is willing to assume consistently with its strategy. Each business strategy implies some amount of risk, in terms of the uncertainty of the results will be achieved; therefore, risk appetite represents a fundamental element of enterprise risk management (ERM) as it sets the risk strategies and allows framing for the current risk profile.

The goal of this paper is to describe the general idea of risk appetite, its implementation framework and the process to set it within a bank with a strong focus on the interactions with other processes such as planning and control, performance evaluation and communication.

It should be remarked that risk appetite requires as precondition a proper risk management framework to be in place, e.g. risk identification, measurement and reporting.

Even if risk appetite is a managerial tool, it should comply with regulatory requirements that are shortly described. To provide a full understanding of the risk appetite implementation, how it could be implemented in two other industries—an oil company and a manufacturing firm such as a carmaker—are described.

Keywords: Risk appetite, ERM, planning, capital adequacy, performance evaluation, corporate governance, risk control, stress test, banking regulation.