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Firstly it is important to differentiate between the two. Risk appetite is the level of risk an organisation is willing to accept in pursuit of rewards or its objectives. This is considered different to the actual tolerance level which is what the organisation can deal with.
Risk Appetite will naturally consider its business objectives. It should also consider taking Into account its capital structure and the access it has to capital markets. Considering that the appetite must be in line with the organisations business objectives, several areas come into play and the following points will elaborate this. Liquidity: If it is a bank then this is in reference to Regulatory capital via Basel regulations. If this is a standard business capital can come in the form of retained earnings or share holders capital. The appetite is also determined by its current Credit rating. Many companies do not wish for their reputation to be damaged so their brand will also be a determinate on their risk appetite. The ambition and goals of the company will determine the level of risks it wants to take and the subsequent business environment will naturally affect it and as an example this would be its supply chain management process. Other factor determining the risk appetite would be the current economic environment and its corporate governance. Also the competence of the staff trying to deliver the business objectives should be considered.
Risk tolerance is the maximum risk that an organization is willing to take regarding each level in the organisation which would be strategic, tactical and operational. Determinates are time horizon that one has to invest, future earning capacity, the presence of the asset mix and finally the current capital you have.
