A:

Tier 1 capital, under the Basel Accord, measures a bank's core capital. The tier 1 capital ratio measures a bank's financial health, its core capital relative and its total risk-weighted assets. In 2015, under Basel III, the minimum tier 1 capital ratio is 6%.

Calculate a bank's tier 1 capital ratio by dividing its tier 1 capital by its total risk-weighted assets. Tier 1 capital includes a bank's shareholders' equity and retained earnings. Risk-weighted assets are a bank's assets weighted according to their risk exposure. Regulators use this ratio to determine whether a bank is well capitalized, undercapitalized or adequately capitalized relative to the minimum requirement.

For example, bank ABC has shareholders' equity of \$3 million and retained earnings of \$2 million, so its tier 1 capital is \$5 million. Bank ABC has risk-weighted assets of \$50 million. Consequently, its tier 1 capital ratio is 10% (\$5 million/\$50 million), and it is considered to be well-capitalized compared to the minimum requirement.

On the other hand, bank DEF has retained earnings of \$600,000 and stockholders' equity of \$400,000. Thus, its tier 1 capital is \$1 million. Bank DEF has risk-weighted assets of \$25 million. Therefore, bank DEF's tier 1 capital ratio is 4% (\$1 million/\$25 million), which is undercapitalized because it is below the minimum tier 1 capital ratio under Basel III.

Bank GHI has tier 1 capital of \$5 million and risk-weighted assets of \$83.33 million. Consequently, bank GHI's tier 1 capital ratio is 6% (\$5 million/\$83.33 million), which is considered to be adequately capitalized because it is equal to the minimum tier 1 capital ratio.

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