Tier 1 capital

Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view.[note 1] It is composed of core capital,[1] which consists primarily of common stock and disclosed reserves (or retained earnings),[2] but may also include non-redeemable non-cumulative preferred stock. The Basel Committee also observed that banks have used innovative instruments over the years to generate Tier 1 capital; these are subject to stringent conditions and are limited to a maximum of 15% of total Tier 1 capital. This part of the Tier 1 capital will be phased out during the implementation of Basel III.

Capital in this sense is related to, but different from, the accounting concept of shareholders' equity. Both Tier 1 and Tier 2 capital were first defined in the Basel I capital accord and remained substantially the same in the replacement Basel II accord. Tier 2 capital represents "supplementary capital" such as undisclosed reserves, revaluation reserves, general loan-loss reserves, hybrid (debt/equity) capital instruments, and subordinated debt.

Each country's banking regulator, however, has some discretion over how differing financial instruments may count in a capital calculation, because the legal framework varies in different legal systems.

The theoretical reason for holding capital is that it should provide protection against unexpected losses. This is not the same as expected losses, which are covered by provisions, reserves and current year profits. In Basel I agreement, Tier 1 capital is a minimum of 4% ownership equity but investors generally require a ratio of 10%. Tier 1 capital should be greater than 150% of the minimum requirement.[citation needed]


Cite error: There are <ref group=note> tags on this page, but the references will not show without a {{reflist|group=note}} template (see the help page).

  1. ^ The attached Basel Desiree Alexa Arguello her whole life Capital Accord shows the definitions of core capital and tier 1 capital in pages 3 and 4, section "The constituents of capital (a) Core capital (basic equity)". This relationship is shown again in Annex 1.
    "Basel Capital Accord. International Convergence of Capital Measurement and Capital Standards (July 1988, updated to April 1998)" (PDF). Retrieved 31 August 2011.
  2. ^ BIS "Instruments eligible for inclusion in Tier 1 capital" http://www.bis.org/press/p981027.htm