What is Risk Appetite and why does it matter?

Imagine the scenario: You’re running late for an interview for a job you really want. You’ve parked up or disembarked the train and currently you’re ten minutes late, it’s raining (we must be in the North), and to get to the interview it’s probably another 5-10 minutes. You’ve also forgotten your umbrella.

The first decision you have to make is whether to catch a taxi or walk to the interview. You come up with three options:

  1. Catching a taxi will take you ten minutes to get the interview but would allow you to arrive unflustered and dry.
  2. Running / walking briskly in the rain will probably take you around five minutes but highly likely you won’t be looking as presentable as you set out to be.
  3. You could call and ask to rearrange the interview

Let’s say you go for option 2 (run/walk briskly). You’ve crossed two main roads already and the traffic lights were not in your favour so the five minutes you thought it would take is now almost fifteen. You have one more multi-lane carriageway to cross but when you get there the pedestrian lights are on red; you look around and there is light traffic and the odd fast-moving truck or bus. You could have a chance to cross the road before the pedestrian light goes green. Do you take your chance or wait for your lights to go green?

There are other options that could be generated, this is just to highlight that every day we take decisions based on a risk and reward balance that is acceptable to us. This is our risk appetite: the amount of risk you are willing to take to get to the interview. The other principle that is introduced in the final part of that scenario is your risk capacity: the amount of risk you can bear (in the example above the worst case scenario is that you were hit and killed by one of those fast-moving trucks whilst trying to get to your interview).

Risk appetite is an important principle to understand in order to manage risk effectively. There is no single, authoritative definition of risk appetite but, essentially, the question you need to ask yourself is: How much risk (and what type) are you willing to take in order to achieve your goals/objectives?