The tier 1 leverage ratio is used to determine the capital adequacy of a bank or a holding company, and it places constraints on how a bank may leverage its capital. Calculate a bank's tier 1 leverage ratio| by dividing its tier 1 capital by its average total consolidated assets.
A bank's tier 1 capital is calculated by adding its stockholders' equity and retained earnings and subtracting goodwill. Next, you must calculate the average total consolidated assets by averaging the bank's most recent quarterly assets from the bank's most recent consolidated report of condition and income, also known as the call report.
If a bank's leverage ratio is greater than or equal to 5%, it is considered to be well-capitalized. If its leverage ratio is 4%, the bank is considered adequately capitalized. The bank is undercapitalized if its leverage ratio is less than 4%. If the bank's leverage ratio is less than 3%, it is considered significantly undercapitalized.
For example, bank Z has tier 1 capital of $1 million and average total consolidated assets of $16 million. Therefore, its tier 1 leverage ratio is 6.25% ($1 million/$16 million), and it is considered to be well-capitalized.
On the other hand, bank Y has tier 1 capital of $2 million and average total consolidated assets of $66.66 million. Consequently, its leverage ratio is 3% ($2 million/$66.66 million) and bank Y is considered adequately capitalized.
Bank X has tier 1 capital of $5 million and average total consolidated assets of $260 million. Thus, the bank is significantly undercapitalized because its leverage ratio is 1.92% ($5 million/$260 million).