Should the capacity for loss be greater than the tolerance for loss?

The capacity for loss should be greater than the tolerance for loss because these two concepts serve different purposes in risk management. The capacity for loss refers to the maximum amount or level of loss that an organization can sustain without jeopardizing its operations or overall financial health. On the other hand, tolerance for loss reflects the organization's willingness to accept a certain level of loss based on its risk appetite and strategic objectives.

If the capacity for loss is greater than the tolerance for loss, it ensures that an organization has a sufficient buffer to absorb unexpected losses. This situation is crucial for maintaining stability and sustainability in the face of risk. By having a higher capacity than the tolerance, an organization is better equipped to handle potential financial impacts without compromising its operations or strategic goals.

In contrast, if the capacity equals or is less than the tolerance for loss, it may lead to risk exposure that the organization cannot effectively manage, which might result in more severe consequences, including operational disruptions or financial failures. This is particularly important in dynamic environments or during periods of uncertainty, where potential losses can exceed initial estimates.