How does risk tolerance differ from risk appetite?

Risk tolerance refers to the specific level of risk an organization is willing to accept for individual activities or decisions. It is a nuanced and contextual measure that reflects the organization's willingness to engage in particular risks based on their unique circumstances and operational requirements. For instance, a company might have a high risk tolerance for innovative projects that have the potential for high returns, while simultaneously maintaining a low tolerance for risks that could impact employee safety or compliance with regulations.

In contrast, risk appetite is generally defined as the overall level of risk that an organization is prepared to pursue or retain in its entirety, encompassing all its activities or strategies. It sets the overarching limits for risk-taking behavior across the organization.

Understanding the distinction between risk tolerance and risk appetite is crucial for effectively managing risks at both the organizational and individual activity levels. Risk tolerance provides the granularity needed to evaluate specific situations, while risk appetite provides a broader strategic context.