Key Risk Interpreters: Understanding Risk Tolerance and Risk Appetite

Updated: Aug 1

Vector Representation of KRI, Risk tolerance and appetite through a speedometer
Understanding Difference Between Risk Tolerance and Risk Appetite

In a capitalist economy, the coin that dictates the success of any entity has clear inscriptions on its face, "Bigger the risk, Bigger the reward." Although the flip side of this coin is often ignored, which ends with "Bigger the fall." This leads to many organizations misjudging their risk potential, thereby sailing their organizations recklessly through the market tides, which often leads to catastrophic consequences.

To avoid such dreaded events, organizations have developed processes through which they can credibly measure their ability to take risks. Such processes involve Key Risk Indicators that assess an organization's Risk Tolerance and Risk Appetite. However, before we dive into such concepts, let us first understand the meaning of key risk indicators.

Key Risk Indicator (KRI)

A KRI is a metric for measuring an event's probability combined with its likely consequences on the organization. It is essentially a measure of how risky an activity is. A KRI framework proves to be advantageous as it can predict potential risks that can harm the organization as well as the possible vulnerabilities in the organization.

KRI metrics essentially act as indicators of risks and threats. They are not defense mechanisms for damage control, but rather signifiers of an organization’s performance and indicators of improvement. Without such Key Risk Indicators, any organization will fail to measure its performance and the metrics that cause its growth hindrance. For instance, a retail-based business will use KRIs like the number of customer complaints, staff accountability, and employee dissatisfaction to measure the risk of performing poorly. Such a business can put measures in place when these KRIs reach a threshold value or change sharply in a short amount of time.

Risk Appetite

Risk appetite is term organizations use to describe the level of risk they can afford to take lest they won't be able to scale. It's the amount of risk an institution is willing to take on to generate more profit.

KRIs provide the essential metric for an organization to set their Risk Appetite. If the risk appetite is low, it will be more selective with the investments and the risks it takes, while the same with a high-risk appetite will invest in a wide range of investments to maximize an organization’s return. It is possible for companies to actively manage their risk appetite.

Risk Appetite in Information Security

Risk appetite takes on a slightly different meaning in the cyber world - it's focused on protecting an organization’s data assets. With new security technologies, it's much easier for companies to reduce their cyber-risk appetite. That's because these technologies automatically protect customer data and address vulnerabilities before they can be exploited. But every organization has different needs and concerns, so several factors determine your organization's Infosec risk appetite.

Keep in mind that Risk Appetite is not a permanent state as it changes over time depending upon the current business operating model, business performance, market position, and the macroeconomic landscape.

Risk Tolerance

Across each KRI - businesses will have a threshold up to which they will be able to sustain the damage that may incur due to various events without negatively impacting the operations in a significant sustained manner. This threshold is termed Risk Tolerance. This can include things such as organizational performance, customer satisfaction, financial stability, and more.

Risk Tolerance in Information Security

Risk Tolerance, similar to risk appetite tackles infosec with a different approach. It indicates the degree to which an organization needs its information to be protected. In the field of Information Security, organizations must tread the line between under and over the protection of data. The management has to come to a resounding conclusion of what information needs to be protected, the data security measures to be undertaken, and mitigation strategies to be used in case of an incident.

Risk Appetite vs. Risk Tolerance in Information Security

On the surface level, Risk Tolerance and Appetite may seem similar, but there is a difference that will become more apparent once you go into their nuances. When we juxtapose both Risk Appetite and Risk Tolerance, we see that Risk Tolerance is more concerned with the amount of risk an organization is willing to take per risk. In contrast, Risk Appetite addresses the total amount of risk that an organization assumes for its business-as-usual activities. Either way, KRIs are the key to understanding the Risk Appetite and Tolerance of an organization.

Final Word

The concepts iterated above may be complex in their explanation, but they stem from fundamental human understanding, wherein we try to take appropriate risks and avoid too many reckless risks. In a field like Infosec, where both data security and user experience have to stand at odds with each other sometimes, KRIs can serve as a compass helping the organization's charter through the volatile market tides.

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