Tier 1 Common Capital Ratio

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DEFINITION of 'Tier 1 Common Capital Ratio'

A measurement of a bank's core equity capital compared with its total risk-weighted assets. This is the measure of a bank's financial strength. The Tier 1 common capital ratio excludes any preferred shares or non-controlling interests when determining the calculation. This differs from the Tier 1 capital ratio which is 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. Central banks typically develop the weighting scale for different asset classes, such as cash and coins, which have zero risk, versus a letter or credit, which carries more risk. The risk-weighted assets essentially measure the firm's assets in terms of risk, typically in terms of 0%, 20%, 50% or 100%.

BREAKING DOWN 'Tier 1 Common Capital Ratio'

Regulators use the Tier 1 common capital ratio to grade a firm's capital adequacy as one of the following rankings: Well-Capitalized, Adequately Capitalized, Undercapitalized, Significantly Undercapitalized, and Critically Undercapitalized. A firm must have a Tier 1 capital ratio of 6% or greater and not pay any dividends or distributions that would affect its capital to be classified as Well-Capitalized. A firm is Adequately Capitalized with a Tier 1 ratio of 4% or more; Undercapitalized below 4%, Significantly Undercapitalized below 3%, and Critically Undercapitalized at 2% or below. Firms that are ranked Undercapitalized or below are prohibited from paying any dividends or management fees. In addition, they are required to file a capital restoration plan.

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