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How effective are your risk tolerance processes?

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Risk tolerance is the amount and type of risk that an organization is willing and able to accept in pursuit of its objectives. It is a key component of risk management, as it helps to align the risk appetite and strategy of the organization, and to communicate the expectations and boundaries for risk taking. However, many organizations struggle to define, measure, and monitor their risk tolerance effectively, resulting in potential gaps, inconsistencies, and inefficiencies in their risk management processes. In this article, we will explore some of the common challenges and best practices for developing and implementing effective risk tolerance processes.

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Abdelaziz Zobairi

Assurance Tech Risk Senior Manager @EY
Laurence Khoo

Pioneering Agricultural Risk Intelligence
Nigel Yarna, CFA

Chartered Financial Analyst, Investment Banker, Integrated Gas Value Chain Contract Manager

1 Why is risk tolerance important?

Risk tolerance is important because it helps to ensure that the organization is taking the right level and type of risk for its goals, and that it is not exposing itself to unacceptable or unnecessary risks. By defining and communicating the risk tolerance, the organization can foster a culture of risk awareness and accountability, where everyone understands their roles and responsibilities in managing risk. Moreover, risk tolerance can help to optimize the allocation of resources and capital, as well as to enhance the performance and value creation of the organization.

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Laurence Khoo

Pioneering Agricultural Risk Intelligence
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Risk tolerance is indeed a weighty topic and one too often glossed over in business planning. Part of good ERM planning is looking at the internal environment of the business and working within this to ensure the relevant strategic and operational objectives of the business are protected by identification of the relevant risks to the business and relevant BC planning to ensure that events that occur that could cause financial, physical or reputational loss to the business are responded to accordingly. Whether this response is through internal measures or through insurance program response, these are all crucial to understanding risk tolerance!

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2 How to define risk tolerance?

Defining risk tolerance is a complex process requiring a systematic and collaborative approach between senior management and the board, as well as the relevant functions and units. It involves considering the organization's vision, mission, values, strategy, objectives, stakeholders, environment, and capabilities. Moreover, risk tolerance can vary depending on the type, source, and impact of the risk, as well as the time horizon and frequency of the risk assessment. The key steps for defining risk tolerance include establishing a risk appetite statement to articulate the overall level and direction of risk that the organization is willing to accept; identifying key risk categories and indicators; setting risk tolerance levels and thresholds; and documenting and approving a risk tolerance framework.

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Abdelaziz Zobairi

Assurance Tech Risk Senior Manager @EY
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It all comes down to the strategy and the business case of the organization. The leadership needs to clearly articulate what are its objectives and what is the level of risks that the organization is willing to take to achieve these objectives.

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3 How to measure risk tolerance?

Measuring risk tolerance is the process of assessing and reporting the actual or expected level and type of risk the organization is taking or facing, and comparing it to predefined levels and thresholds. This helps to monitor the risk exposure and performance of the organization, as well as identify any deviations or breaches that may require corrective actions or escalation. The key steps for measuring risk tolerance include collecting and analyzing data from various sources, such as internal reports, external benchmarks, surveys, audits, or simulations; calculating and evaluating risk indicators based on different methods and models; and reporting and communicating the results in different formats and frequencies, such as dashboards, heat maps, or alerts.

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Nigel Yarna, CFA

Chartered Financial Analyst, Investment Banker, Integrated Gas Value Chain Contract Manager
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Stress testing models by easily understood changes in one variable and showing the impact helps bridge the communication gap in showing how some risk up to a certain level can be acceptable.

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4 How to monitor risk tolerance?

Monitoring risk tolerance is the process of reviewing and updating the risk tolerance framework and levels to ensure they remain relevant and effective. This is done to adapt to changes or uncertainties that may affect the risk profile and strategy of the organization. The key steps for monitoring risk tolerance involve conducting regular reviews and audits, which can be done by internal or external parties. Additionally, feedback and input from various stakeholders should be solicited and incorporated, such as from the board, management, staff, customers, regulators, or investors. Lastly, changes and improvements should be implemented and documented due to factors like the achievement or failure of objectives, the emergence or resolution of risks, or the introduction or modification of regulations or standards.

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5 How to improve risk tolerance processes?

Improving risk tolerance processes is an ongoing and iterative effort, designed to increase the quality, efficiency, and value of the risk tolerance for the organization and its stakeholders. Each organization will have its own context, needs, and challenges; however, there are some common best practices for improvement. Aligning the risk tolerance with the risk appetite and strategy ensures that it reflects and supports the vision, mission, values, objectives, and capabilities of the organization. Engaging and empowering stakeholders will create a culture of risk ownership and accountability, while leveraging the expertise, experience, and perspectives of different functions and units. Simplifying and standardizing the risk tolerance framework and levels reduces complexity and ambiguity while facilitating communication and application. Finally, integrating and automating data and systems improves accuracy and timeliness of measurement and reporting, enabling monitoring and analysis of the risk tolerance.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How effective are your risk tolerance processes?

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3

4

5

6

1 Why is risk tolerance important?

2 How to define risk tolerance?

3 How to measure risk tolerance?

4 How to monitor risk tolerance?

5 How to improve risk tolerance processes?

6 Here’s what else to consider

Risk Management

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How effective are your risk tolerance processes?

1

2

3

4

5

6

1 Why is risk tolerance important?

2 How to define risk tolerance?

3 How to measure risk tolerance?

4 How to monitor risk tolerance?

5 How to improve risk tolerance processes?

6 Here’s what else to consider

Risk Management

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