Risk Capacity

Risk Capacity

Risk Capacity Jonathan Poland

Risk capacity is the maximum level of risk that an organization or individual is able to withstand in order to achieve their goals. It represents the total amount of risk exposure that is consistent with the organization’s or individual’s strategy and objectives. Risk capacity is often compared to risk tolerance, which refers to an organization or individual’s willingness to take on risk. Risk tolerance may be influenced by factors such as the organization’s or individual’s risk appetite, risk culture, and risk management capabilities.

Determining an organization’s or individual’s risk capacity involves evaluating the potential consequences of different risks and assessing the organization’s or individual’s ability to absorb or mitigate those risks. This can be done using a variety of techniques, such as risk assessment tools, risk analysis techniques, or risk management software. Understanding risk capacity is an important aspect of risk management, as it helps organizations and individuals to align their risk-taking with their goals and objectives. By accurately assessing risk capacity, organizations and individuals can make more informed decisions about the risks they are willing and able to take on, and allocate resources more effectively to manage and mitigate those risks. The following are illustrative examples of a risk capacity.

Investing

An investor is completely risk adverse but wants to make 7% per year to meet their goals for retirement. This may require the investor to increase their risk capacity beyond their risk tolerance. The exact level of risk required depends on market conditions, particularly interest rates. If interest rates are near 7%, the investor may achieve their goals with little risk. Alternatively, if interest rates are near 0% significant risk may be required to have any chance of returns exceeding 7%.

Risk Management

An investment manager is expected to outperform the market which typically requires taking on more risk than the market average. However, the investment manager is also constrained to a risk exposure level set by a risk management team. This risk exposure level can be described as the manager’s risk capacity.

Professional

A professional wants a promotion within a year to pay for changes to their lifestyle. This typically requires taking on additional responsibilities and increased visibility. If the individual is risk adverse, they may need to take on risk exposure that exceeds their risk tolerance to have a realistic chance of a timely promotion.

Projects

An IT project has zero risk tolerance, needs to be completed in a month, has a $1 million budget and a long list of requirements that are all high priority. A risk analysis shows that there is an 95% chance of project failure with a total risk exposure of $5 million meaning that the budget and schedule have a high probability of significant overruns. The business unit has a choice to accept this risk and proceed as planned with a $5 million risk capacity. Alternatively, dropping requirements, extending budget and increasing timelines will reduce risk capacity towards their risk tolerance level.

Dread Risk

A dread risk is a risk that people fear such that they are willing to pay to minimize risk exposure. When the goal is to minimize risk, risk capacity is near zero and risk exposure is driven as low as is feasible given constraints such as budget and technical limitations. For example, the public expect aircraft to be extremely safe and it is not considered acceptable to take risks with flight safety.

Unmanaged Risk

An unmanaged risk is a risk that isn’t managed despite its ability to disrupt your goals. In this case, risk capacity may be low as you aren’t expecting an unmanaged risk to disrupt your plans but actual risk exposure may be very high as nothing is done to treat risk. For example, a society that leaves known environmental risks unmanaged despite the likelihood these risks will disrupt quality of life, health and economic goals.

Learn More
Business Verbs Jonathan Poland

Business Verbs

Business verbs are action words that are commonly used in business communication to describe goals, plans, and achievements. These verbs…

Modular Products Jonathan Poland

Modular Products

Modular products are products that are made up of standardized, interchangeable parts or modules that can be easily assembled and…

Taxes Jonathan Poland

Taxes

Taxes are mandatory financial contributions that are levied by a government on individuals, businesses, and other organizations. The money collected…

Project Communication Jonathan Poland

Project Communication

Project communication is the exchange of information and messages that occurs during the planning, execution, and evaluation phases of a…

Strategic Planning Techniques Jonathan Poland

Strategic Planning Techniques

Strategic planning is the process of defining an organization’s direction and making decisions on allocating its resources to pursue this…

What is Design Risk? Jonathan Poland

What is Design Risk?

Design risk refers to the potential negative consequences that a business may face as a result of problems or issues…

What is a Self-Replicating Machine? Jonathan Poland

What is a Self-Replicating Machine?

Self-replicating machines are robots or nanobots that are capable of producing copies of themselves, using scavenged materials and energy to…

Interest Rate Risk Jonathan Poland

Interest Rate Risk

Interest rate risk is the risk that changes in interest rates will negatively impact the value of an investment or…

What is Cultural Fit? Jonathan Poland

What is Cultural Fit?

Culture fit refers to the compatibility of a candidate’s attitudes and experiences with an organization’s culture. It is a hiring…

Search →
content database

Search my thinking on business, finance,
and the capital markets or start below

Risk Monitoring Jonathan Poland

Risk Monitoring

Risk monitoring is the ongoing process of keeping track of risks and managing them effectively. The risk management process often…

Root Cause Analysis Jonathan Poland

Root Cause Analysis

Root cause analysis (RCA) is a method of identifying the underlying causes of a problem or issue in order to…

Research Design Jonathan Poland

Research Design

Research design is the overall plan or approach that a researcher follows in order to study a particular research question.…

Government Contract Timeline 150 150 Jonathan Poland

Government Contract Timeline

A government contract award timeline can vary depending on the specific country, agency, and procurement process in question. In general,…

Niche vs Segment Jonathan Poland

Niche vs Segment

A niche is a specific, identifiable group of customers who have unique needs and preferences that are not shared by…

Brand Engagement Jonathan Poland

Brand Engagement

Brand engagement refers to the interaction between a customer and a brand, and can be used as a way to…

Workplace Issues Jonathan Poland

Workplace Issues

Workplace issues can negatively impact employee satisfaction and organizational performance. These issues often arise from cultural and systemic problems, and…

What are Field Services? Jonathan Poland

What are Field Services?

Field service involves managing and deploying resources and assets at customer, public, and third-party locations, as well as providing services…

Feasibility Analysis Jonathan Poland

Feasibility Analysis

Feasibility analysis is the process of evaluating the potential of a proposed project or system to determine whether it is…