How is risk tolerance different from risk appetite?

Risk appetite and risk tolerance are indeed distinct concepts in the realm of risk management, and the chosen response accurately captures this difference.

Risk appetite refers to the overall level of risk that an organization is willing to accept in order to achieve its objectives. It embodies the organization’s strategic goals and the level of risk it is ready to bear across various scenarios. This can include a wide range of risk types, not just financial, but also operational, reputational, and other risks.

On the other hand, risk tolerance is more specific and usually defined in the context of particular risks or situations. It reflects the acceptable level of variation around the risk appetite, allowing for some operational flexibility. Essentially, while risk appetite sets the broad parameters of risk that an organization will consider acceptable, risk tolerance provides a more granular threshold for individual risks within that framework.

Understanding this distinction is vital for organizations as they develop their risk management strategies, ensuring they align operational decisions with overarching business goals.