Next video:

The Tier 1 capital ratio is a measure of a depository financial institution’s financial health and capital adequacy. The ratio was developed as part of the Basel III Accords, which focused on individual bank’s liquidity coverage ratio, net stable funding ratio, the establishment of liquidity risk management supervision principles, and monitoring metrics.

The formula for calculating the Tier 1 capital ratio is:

Tier 1 Capital / Risk-Weighted Assets

A bank’s Tier 1 capital is comprised of the bank’s common stock and its retained earnings. It may also include disclosed reserves and non-redeemable, non-cumulative preferred stock.

Risk-weighted assets is the bank’s loan portfolio measured to determine the riskiness of each loan. The riskier the loan, the less it counts toward the total. For instance, a collateralized loan has less risk than an uncollateralized letter of credit.

Regulators use the Tier 1 capital ratio to rate a financial institution’s capital adequacy. The possible ratings include well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. To be considered well capitalized, a financial institution must have a Tier 1 capital ratio of 6% or better.

A bank with a ratio of 3% or less is considered undercapitalized. A 2% or less ratio is considered critically undercapitalized. Banks with these ratios are prohibited from paying dividends or management fees. Additionally, they must file a capital restoration plan showing how they will get their Tier 1 capital ratio to 4% or above.

## In This Series

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

### 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.
3. Personal Finance

### Explaining Tier 1 Capital

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

### Explaining the Tier 1 Leverage Ratio

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

### 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 ...
6. 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.
7. Investing

### Using Economic Capital To Determine Risk

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

### The Biggest Risks of Investing in Bank of America Stock

Learn the largest risks to owning Bank of America stock. Discover its outlook through fundamental analysis and external risks to the company and its industry.