Risk Capital denotes financial resources (variably called own funds, equity, shareholder funds) that are provided by the owners / investors of a firm to support its operations. Risk capital is characterised by the lack of any explicit guarantee that those funds will be returned (the funds are at-risk).
Risk capital for levered firms
When a firm choose to fund itself also with debt liabilities (loans, bonds etc.) the amount of risk capital has a direct impact on the Credit Risk of those liabilities.
Bank & Insurance Firms Risk Capital
Regulated financial institutions such as banks and insurance firms cannot hold discretionary amounts of risk capital but are obliged to follow specific regulatory frameworks (as those are applied in various jurisdictions).
Issues and Challenges
- Especially after the financial crisis of 2008, the ability of regulatory frameworks to ensure capital adequacy for regulated financial firms has come to question. This has led to a number of amendments, including the widespread adoption of Regulatory Stress Testing. Alternative proposals recommend that financial institutions must hold significantly more capital to effectively render them risk free.