Risk Capacity

Risk capacity is about ability, not willingness. It depends on objective factors such as income, wealth, time horizon, financial obligations, liquidity needs and, for organisations, capital and regulatory limits.

For example, a 30-year-old with a secure job, an emergency fund and no immediate need for their retirement savings has high risk capacity, because they can wait for investments to recover from a market fall. A retiree who depends on their savings for living costs has lower risk capacity, even if they enjoy taking risks.

Risk capacity differs from risk tolerance, which is about attitude and comfort with uncertainty, and from risk appetite, which in organisations describes how much risk they choose to accept. A sound investment plan or risk policy should not exceed risk capacity, even if risk tolerance is high.

For banks and insurers, risk capacity is linked to their capital. Taking on more risk than their capital can absorb would threaten their solvency, which is why regulators set minimum capital requirements.