Loading the player...

What is the 'Tier 1 Capital Ratio'

The tier 1 capital ratio is the ratio of a bank’s core tier 1 capital – its equity capital and disclosed reserves – to its total risk-weighted assets. It is a key measure of a bank's financial strength that has been adopted as part of the Basel III Accord on bank regulation.

BREAKING DOWN 'Tier 1 Capital Ratio'

The tier 1 capital ratio is the basis for the Basel III international capital and liquidity standards devised after the financial crisis, in 2010. The crisis showed that many banks had too little capital to absorb losses or remain liquid, and were funded with too much debt and not enough equity.

To force banks to increase capital buffers, and ensure they can withstand financial distress before they become insolvent, Basel III rules would tighten both tier-1 capital and risk-weighted assets (RWAs). The equity component of tier-1 capital has to have at least 4.5% of RWAs. The tier-1 capital ratio has to be at least 6%. Basel III also introduced a minimum leverage ratio, with Tier-1 capital must be at least 3% of total assets, and more for global systemically important banks that are too big to fail. The Basel III rules have yet to be finalized due to an impasse between the U.S. and Europe.

Calculating a Tier 1 Capital Ratio

The tier 1 capital ratio measures a bank’s core equity capital against its total risk-weighted assets – which include all the assets the bank holds that are systematically weighted for credit risk. For example, a bank’s cash on hand and government securities would receive a weighting of 0%, while its mortgage loans would be assigned a 50% weighting.

Tier 1 capital is core capital and is comprised of a bank's common stock, retained earnings, accumulated other comprehensive income (AOCI), noncumulative perpetual preferred stock and any regulatory adjustments to those accounts.

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%.

For more on Basel III and capital adequacy regulations for banks, read Understanding The Basel III International Regulations.

RELATED TERMS
  1. Tier 1 Capital

    Tier 1 capital is a term used to describe the capital adequacy ...
  2. Basel III

    Basel III is a comprehensive set of reform measures designed ...
  3. Tier 1 Common Capital Ratio

    The Tier 1 common capital ratio is a measurement of a bank's ...
  4. Basel II

    Basel II is a set of banking regulations put forth by the Basel ...
  5. Basel Accord

    The Basel Accord is a set of agreements on banking regulations, ...
  6. Core Capital

    Core capital is the minimum amount of capital that a bank must ...
Related Articles
  1. 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.
  2. Personal Finance

    How Basel 1 Affected Banks

    The 1988 Basel 1 agreement sought to decrease bankruptcies among major international banks.
  3. Investing

    Understanding The Basel III International Regulations

    The Basel III regulations mark a drastic reform in international banking. But how do they impact the future's investment landscape?
  4. Investing

    Basel II Accord To Guard Against Financial Shocks

    Problems with the original accord became evident during the subprime crisis in 2007.
  5. Investing

    Using Economic Capital To Determine Risk

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

    Useful metrics for evaluating bank stocks

    Learn which metrics are most useful to evaluate companies in the banking sector and the issues when comparing them across the various banks.
  7. Managing Wealth

    An Investor's Guide To Bank Stress-Testing

    Just how are bank stress tests performed and what is the logic behind them? And is a stress test useful for evaluating a bank's stock?
  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.
  9. Personal Finance

    The Dirty Secret About Your Credit Score

    The tier system of credit scores leaves borrowers with little wiggle room.
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. 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 >>
  3. What is the Federal Reserve Board's market risk capital rule?

    Learn about the market risk capital rule enacted by the Federal Reserve, and understand how this it reflects Basel III international ... Read Answer >>
  4. What is the minimum liquidity coverage ratio that a bank must have from 2016 to 2 ...

    Learn the purpose of the new liquidity coverage ratio requirements under the Basel III standards, and see the phase-in of ... Read Answer >>
  5. Why is the capital adequacy ratio important to shareholders?

    Understand what the capital adequacy ratio is and why it is a very important metric of financial soundness for evaluating ... Read Answer >>
  6. How do leverage ratios help to regulate how much banks lend or invest?

    Learn what leverage ratios mean for banks, how regulators restrict leverage, and what impact ratios have on a bank's ability ... Read Answer >>
Trading Center