Risk appetite: A crucial consideration for effective board risk oversight

Christopher E. Mandel and Soubhagya Parija
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Christopher E. Mandel: Instructor of the ERM Practice, Embry-Riddle Aeronautical University, USA
Soubhagya Parija: Former Chief Risk Officer, FirstEnergy Corp, USA

Journal of Risk Management in Financial Institutions, 2024, vol. 17, issue 2, 168-182

Abstract: Progressive risk management has, among other things, inferred that effectively managing risk requires significant commitment to a risk appetite framework (RAF) that educates, trains and enables decision makers to make risk decisions in the context of understanding risk-taking capacity, preference and, ultimately, need. The starting point for this assumes a reliable measure of the current levels of risk has already been taken to understand the wherewithal to take incremental risk — taken for its potential to increase value. Yet, the need for commitment and investment by leadership can be hard to secure. Proving the value and reliability of a RAF is also not easily accomplished. Thus, RAFs have not been widely established across different industries, not nearly as much as in the financial services. Research shows that proving RAFs' impacts on performance is necessary for successful implementation. Both the literature and testimonies of successful practitioners demonstrate that risk culture, strategic priorities, board risk oversight requirements, effective communications to stakeholders, reliable quantification of risk and a commitment to quality decision making that sufficiently considers relevant risks are all crucial to successfully managing risk taking guided by a RAF. Thus, after being properly designed, thoroughly tested and ultimately approved by senior management and the board, a risk appetite strategy (RAS) and RAF can be instrumental in more effectively managing and creating value, ultimately leading to a more resilient enterprise. This paper will delve into the many elements of RAFs, allowing the reader to fully understand why management and governance should support their use. It will cover the challenges that practitioners face and how to resolve them. It will also provide a step-by-step methodology for designing, implementing and operationalising a RAS, including the roles of key players in doing so.

Keywords: risk; risk appetite; risk oversight; risk tolerance; governance; performance; decision making (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2024
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