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]
The Tier 1 capital ratio is the ratio of a bank's core equity capital to its total risk-weighted assets (RWA). Risk-weighted assets are the total of all assets held by the bank weighted by credit risk according to a formula determined by the Regulator (usually the country's central bank). Most central banks follow the Basel Committee on Banking Supervision (BCBS) guidelines in setting formulae for asset risk weights. Assets like cash and currency usually have zero risk weight, while certain loans have a risk weight at 100% of their face value. The BCBS is a part of the Bank of International Settlements (BIS). Under BCBS guidelines total RWA is not limited to Credit Risk. It contains components for Market Risk (typically based on value at risk (VAR) ) and Operational Risk. The BCBS rules for calculation of the components of total RWA have seen a number of changes following the Financial crisis of 2007–08.[3]
As an example, assume a bank with $2 of equity lends out $10 to a client. Assuming that the loan, now a $10 asset on the bank's balance sheet, carries a risk weighting of 90%, the bank now holds risk-weighted assets of $9 ($10 × 90%). Using the original equity of $2, the bank's Tier 1 ratio is calculated to be $2/$9 or 22%.
There are two conventions for calculating and quoting the Tier 1 capital ratio:
Tier 1 common capital ratio and
Tier 1 total capital ratio
Preferred shares and non-controlling interests are included in the Tier 1 total capital ratio but not the Tier 1 common ratio.[4] As a result, the common ratio will always be less than or equal to the total capital ratio. In the example above, the two ratios are the same.
^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.
^"International regulatory framework for banks (Basel III)". Bank of International Settlements (BIS). Retrieved 8 February 2012.
^"Investopedia:Tier 1 Common Capital Ratio". Investopedia.
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January 01, 1970
tier, capital, this, article, needs, additional, citations, verification, please, help, improve, this, article, adding, citations, reliable, sources, unsourced, material, challenged, removed, find, sources, news, newspapers, books, scholar, jstor, october, 202. This article needs additional citations for verification Please help improve this article by adding citations to reliable sources Unsourced material may be challenged and removed Find sources Tier 1 capital news newspapers books scholar JSTOR October 2020 Learn how and when to remove this message 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 Contents 1 Tier 1 capital ratio 2 See also 3 Notes 4 References 5 External linksTier 1 capital ratio editThe Tier 1 capital ratio is the ratio of a bank s core equity capital to its total risk weighted assets RWA Risk weighted assets are the total of all assets held by the bank weighted by credit risk according to a formula determined by the Regulator usually the country s central bank Most central banks follow the Basel Committee on Banking Supervision BCBS guidelines in setting formulae for asset risk weights Assets like cash and currency usually have zero risk weight while certain loans have a risk weight at 100 of their face value The BCBS is a part of the Bank of International Settlements BIS Under BCBS guidelines total RWA is not limited to Credit Risk It contains components for Market Risk typically based on value at risk VAR and Operational Risk The BCBS rules for calculation of the components of total RWA have seen a number of changes following the Financial crisis of 2007 08 3 As an example assume a bank with 2 of equity lends out 10 to a client Assuming that the loan now a 10 asset on the bank s balance sheet carries a risk weighting of 90 the bank now holds risk weighted assets of 9 10 90 Using the original equity of 2 the bank s Tier 1 ratio is calculated to be 2 9 or 22 There are two conventions for calculating and quoting the Tier 1 capital ratio Tier 1 common capital ratio and Tier 1 total capital ratio Preferred shares and non controlling interests are included in the Tier 1 total capital ratio but not the Tier 1 common ratio 4 As a result the common ratio will always be less than or equal to the total capital ratio In the example above the two ratios are the same See also edit nbsp Business and economics portal Bank for International Settlements Bank stress tests Basel Accords Basel Committee on Banking Supervision Capital requirement and reserve requirement Contingent convertible bond Tier 2 capitalNotes edit By definition of Bank for International Settlements References edit 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 BIS Instruments eligible for inclusion in Tier 1 capital http www bis org press p981027 htm International regulatory framework for banks Basel III Bank of International Settlements BIS Retrieved 8 February 2012 Investopedia Tier 1 Common Capital Ratio Investopedia External links editBank for International Settlements Retrieved from https en wikipedia org w index php title Tier 1 capital amp oldid 1196671321 Tier 1 capital ratio, wikipedia, wiki, book, books, library,
