Risk capital
A narrow definition of risk capital is that it is the capital available within the business required to absorb a defined level of possible losses before the bank faces insolvency. Required risk capital is estimated assuming a specified holding period and confidence level. The level of risk capital required, as defined by management, may be more or less than the bank’s actual level.
Funding capital
Capital provides free funds in the sense that the bank does not pay interest on these funds. It is not free in the sense that shareholders require a return on their capital and it should be priced at the bank’s cost-of-equity (COE ). This role may be incorporated into financial planning and reporting though the use of hurdle rates that set minimum required returns or by explicit charges to internal business units for capital allocated to them.