Related Terms
DEFINITION
Risk Appetite (RA)
Risk appetite refers to the level and type of risk that a financial institution is willing and able to accept. This is very important when talking about Anti-Money Laundering and Combating the Financing of Terrorism regulations as they require financial institutions to take a risk-based approach. Risk appetite is defined by senior management and the board of directors and serves as a framework for decision-making. To assess and define the risk appetite, stress testing is commonly used, which is an analytical technique to show how a given financial institution will be affected by certain financial events.
Synonyms
Risk tolerance, risk capacity
Acronyms
RA
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Synonyms
Risk tolerance, risk capacity
Acronyms
RA
Examples
A regional bank has a defined risk appetite for its lending activities. It decides to cap high-risk commercial loans to 20% of its total loan portfolio to balance potential profits with risk exposure. Therefore, loans that go over this threshold would have to be approved by the relevant authority on an individual basis.
FAQ
How is risk appetite determined in a financial institution?
Determining the risk appetite is a collaborative process involving senior management, risk officers, and the board of directors. They consider the institution’s strategic objectives, financial capacity, regulatory requirements, market conditions and stakeholder expectations to work out the risk appetite of their business.
What is the difference between risk appetite and risk tolerance?
Risk appetite is the broader of the two terms, defining in broad terms the overall level of risk a bank is willing to take on. Risk tolerance on the other hand, is more specific and defines the acceptable variation from the risk appetite in day-to-day activities.
Why is risk appetite important for banks?
Defining and sticking to a risk appetite ensures that a bank operates within its financial and operational capacity while still pursuing growth and profitability. It allows banks to align risk-taking activities with their strategic goals, minimizing the likelihood of unexpected losses.
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