Loading the player...

What is the 'Tier 1 Capital Ratio'

The tier 1 capital ratio is the comparison between a banking firm's core equity capital and its total risk-weighted assets. A firm's core equity capital is known as its tier 1 capital and is the measure of a bank's financial strength based on the sum of its equity capital and disclosed reserves, and sometimes non-redeemable, non-cumulative preferred stock. A firm's risk-weighted assets include all assets that the firm holds that are systematically weighted for credit risk.

BREAKING DOWN 'Tier 1 Capital Ratio'

Tier 1 capital for a banking firm includes the value of its common stock, retained earnings, accumulated other comprehensive income (AOCI), noncumulative perpetual preferred stock and any adjustments to those accounts. The amount of tier 1 capital a bank holds and its proportion to its risk-weighted assets are important. In times of financial distress or recession, tier 1 capital is the first to absorb losses before other investors, such as debt holders, experience losses. The tier 1 capital ratio signifies how well a bank can withstand financial distress before it becomes insolvent.

Central banks typically develop the weighting scale for different asset classes, such as cash and government securities, which have zero risk, versus a mortgage loan, which carries more risk. A banking firm's cash on hand and government securities would receive a weighting of 0% when calculating its risk-weighted assets, for example, while its mortgage loans would be assigned a 50% weighting.

The Importance of the Tier 1 Capital Ratio

Regulators use the tier 1 capital ratio to grade a firm's capital adequacy as well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized. To be classified as well-capitalized, a firm must have a tier 1 capital ratio of 6% or greater under Basel III requirements and must not pay any dividends or distributions that would affect its capital. The original threshold for the tier 1 capital ratio under Basel I was 4%. Firms that are ranked as undercapitalized or below are prohibited from paying any dividends or management fees. In addition, they are required to file capital restoration plans.

Calculating a Tier 1 Capital Ratio

A bank has $10 billion in common stock and $2 billion in retained earnings. Adding these two values together, the bank has $12 billion in tier 1 capital. After weighing its assets according to risk, the bank has $120 billion in risk-weighted assets. Dividing the $12 billion in tier 1 capital by the $120 billion in risk-weighted assets gives the bank a tier 1 capital ratio of 10%.

RELATED TERMS
  1. Tier 1 Common Capital Ratio

    A measurement of a bank's core equity capital compared with its ...
  2. Tier 1 Capital

    A term used to describe the capital adequacy of a bank. Tier ...
  3. Tier 3 Capital

    Tertiary capital held by banks to meet part of their market risks, ...
  4. Tier 2 Capital

    One of two categories by which a bank's capital is divided. Tier ...
  5. Tier 1 Leverage Ratio

    The relationship between a banking organization's core capital ...
  6. Capital Adequacy Ratio - CAR

    A measure of a bank's capital. It is expressed as a percentage ...
Related Articles
  1. Investing

    Calculating Tier 1 Common Capital Ratio

    The tier 1 common capital ratio compares a financial institution’s core equity capital to its risk-weighted assets.
  2. Personal Finance

    Calculating the Tier 1 Capital Ratio

    The Tier 1 capital ratio is a measure of a depository financial institution’s financial health and capital adequacy.
  3. Personal Finance

    What's Tier 2 Capital?

    Tier 2 capital is a category of supplementary capital that banks hold.
  4. Personal Finance

    Is Your Bank On Its Way Down?

    Find out how the Tier 1 capital ratio can be used to tell if your bank is going under.
  5. Personal Finance

    Explaining Tier 1 Capital

    Tier 1 capital refers to the core capital a bank must maintain in relation to its assets.
  6. Personal Finance

    Explaining the Tier 1 Leverage Ratio

    The Tier 1 leverage ratio measures a bank’s core capital against its total assets.
  7. Small Business

    Understanding the Capital Adequacy Ratio

    The capital adequacy ratio (CAR) is an international standard that measures a bank’s risk of insolvency from excessive losses. Currently, the minimum acceptable ratio is 8%. Maintaining an acceptable ...
  8. Personal Finance

    Explaining Risk-Weighted Assets

    Risk-weighted assets is a banking term that refers to a method of measuring the risk inherent in a bank’s assets, which is typically its loan portfolio.
  9. Investing

    Using Economic Capital To Determine Risk

    Discover how banks and financial institutions use economic capital to enhance risk management.
  10. Investing

    How Basel 1 Affected Banks

    This 1988 agreement sought to decrease the potential for bankruptcy among major international banks.
RELATED FAQS
  1. How can I calculate the tier 1 capital ratio?

    Learn about the tier 1 capital ratio, what the ratio indicates about a firm's capital adequacy and how to calculate a firm's ... Read Answer >>
  2. What is the difference between tier 1 capital and tier 2 capital?

    Learn what tier 1 capital and tier 2 capital, the differences between them, and how to calcu, alate a bank's capital ratio. Read Answer >>
  3. What are some of the well-known no-load funds?

    Find out more about the capital to risk-weighted assets ratio, what the ratio measures and the formula used to calculate ... Read Answer >>
  4. How do I calculate the capital to risk weight assets ratio for a bank in Excel?

    Learn more about the capital to risk-weighted assets ratio and how to calculate a bank's capital adequacy ratio using Microsoft ... Read Answer >>
  5. How can I calculate the leverage ratio using tier 1 capital?

    Learn about the tier 1 leverage ratio, how to calculate the tier 1 capital ratio and what this leverage ratio indicates about ... Read Answer >>
  6. What is the minimum capital adequacy ratio that must be attained under Basel III?

    Find out more about the capital adequacy ratio, or CAR, and the minimum capital adequacy ratio that banks must attain under ... Read Answer >>
Hot Definitions
  1. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  2. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  3. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  4. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  5. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  6. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
Trading Center