From the course: Introduction to Risk Management

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Risk capacity and risk appetite

Risk capacity and risk appetite

From the course: Introduction to Risk Management

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Risk capacity and risk appetite

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- [Instructor] All companies, including banks, has capital that's been provided by the shareholders of the business. If the bank makes a profit, it will probably pay some of this profit to the shareholders as a dividend, as reward for providing the capital. The rest of the profit? Well, this will be added to the existing capital. If a bank makes a loss, this is absorbed by the capital, which is effectively reducing the amount of capital the shareholders have in the bank. However, because of the capital buffer, the bank is able to continue operating as usual. If this capital buffer is totally wiped out, however, the bank faces a very real threat of becoming insolvent and failing. When a bank takes more risk, it has the chance to make high returns for their shareholders. However, it also increases the chance of losing a lot of money, putting its entire capital buffer in danger of being wiped out. This capital buffer a bank has is finite and limits the amount of risk a bank can take…

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