What is 'Tier 3 Capital'

Tier 3 capital is tertiary capital, which many banks hold in order to support their market risk, commodities risk, and foreign currency risk. Tier 3 capital includes a greater variety of debt than tier 1 and tier 2 capitals (see below).

BREAKING DOWN 'Tier 3 Capital'

Tier 3 capital debts may include a greater number of subordinated issues, undisclosed reserves and general loss reserves as compared with tier 2 capital. To qualify as tier 3 capital, assets must be limited to 250% of a banks tier 1 capital, be unsecured, subordinated, and have a minimum maturity of two years.

The Origin of Tier 3 Capital

Capital tiers for large financial institutions originated with the Basel Accords. These are a set of three (Basel I, Basel II, and Basel III) regulations, which the Basel Committee on Bank Supervision (BCBS) began to roll out in 1988. In general all of the Basel Accords provide recommendations on banking regulations with respect to capital risk, market risk and operational risk. The goal of the accords is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses. While violations of the Basel Accords bring no legal ramifications, members are responsible for the implementation of the accords in their home countries.

Basel I required international banks to to maintain a minimum amount (8%) of capital, based on a percent of risk-weighted assets. Basel I also classified a bank's assets into five risk categories (0%, 10%, 20%, 50% and 100%), based on the nature of the debtor (e.g. government debt, development bank debt, private-sector debt, and more).

In addition to minimum capital requirements, Basel II focused on regulatory supervision and market discipline. Basel II highlighted the division of eligible regulatory capital of a bank into three tiers. BCBS published Basel III in 2009, following the 2008 financial crisis. Basel III sought to improve the banking sector's ability to deal with financial stress, improve risk management, and strengthen banks' transparency.

Tier 1 Capital, Tier 2 Capital, Tier 3 Capital

Tier 1 capital is a bank's core capital, which consists of shareholders' equity and retained earnings; while Tier 2 capital includes revaluation reserves, hybrid capital instruments, and subordinated term debt. In addition Tier 2 capital incorporates general loan-loss reserves and undisclosed reserves. Tier 1 capital is intended to measure a bank's financial health; a bank uses Tier 1 capital to absorb losses without ceasing business operations. Tier 2 capital is supplementary (e.g. less reliable than tier 1 capital.)

A bank's total capital is calculated as a sum of its tier 1 and tier 2 capital. Regulators use the capital ratio to determine and rank a bank's capital adequacy.

Tier 3 capital consists of Tier 2 capital plus short-term subordinated loans.

  1. Tier 2 Capital

    Tier 2 capital is supplementary capital including items like ...
  2. Tier 1 Leverage Ratio

    The relationship between a banking organization's core capital ...
  3. Tier 1 Capital Ratio

    A comparison between a banking firm's core equity capital and ...
  4. Tier 1 Common Capital Ratio

    A measurement of a bank's core equity capital compared with its ...
  5. Total Asset-To-Capital Ratio - ...

    The total asset-to-capital ratio multiple was a regulatory limit ...
  6. Risk-Based Capital Requirement

    Risk-based capital requirements ensure that each financial institution ...
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. Investing

    Basel II Accord To Guard Against Financial Shocks

    Problems with the original accord became evident during the subprime crisis in 2007.
  3. Insights

    Understand the SEC Rules on Equity Crowdfunding

    The SEC's adoption of equity crowdfunding rules, initiated under the JOBS Act, enables small investors to invest in companies that show early potential.
  4. Retirement

    The Tax Implications of Inheriting Assets

    Whether you are passing on assets or inheriting them, it's crucial to be aware of the tax consequences.
  5. 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?
  6. 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.
  7. Insights

    The Decline of the Middle Class: An Inside Look

    Find out what is behind the decline of the middle class in America and how the hourglass economy may effect consumption.
  8. Investing

    BofA to Award Small Businesses as Merrill Edge Investment Balances Increase

    Bank of America rolled out a new program that rewards small business owner clients when their business and investment account balances grow.
  1. What Is the Difference between Tier 1 Capital and Tier 2 Capital?

    Tier 1 capital is a bank's core capital, whereas tier 2 capital is a bank's supplementary capital. Read Answer >>
  2. 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 >>
  3. What average annual growth rate is typical for the banking sector?

    Learn the typical average annual growth rate for the banking sector and why regulatory requirements have a profound effect ... Read Answer >>
  4. How Is Capital Adequacy of a Bank Measured?

    Examine some of the different financial measurements that are most commonly used to assess capital adequacy within the banking ... Read Answer >>
  5. How are international investment banking practices regulated?

    See which international organizations are responsible for overseeing and regulating global investment banks, including the ... Read Answer >>
  6. 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 >>
Trading Center