What Are Undisclosed Reserves?
Undisclosed reserves include unpublished or "hidden" reserves that may not appear on public documents—such as on the balance sheet—but are nonetheless real assets and are considered as such by most banking institutions.
Bank reserves are the cash minimums that financial institutions must keep on hand. The Federal Reserve (Fed) sets the requirements in order to ensure that banks have enough money on hand to cover withdrawals.
- Undisclosed reserves are on the books of a financial institution, but "hidden" from the public and not listed on financial statements.
- Undisclosed reserves are included as part of Tier 2 capital along with general loan-loss and revaluation reserves.
- Some countries' regulatory environments do not recognize undisclosed reserves as assets.
Understanding Undisclosed Reserves
Undisclosed reserves relate to capital requirements in the banking industry and are designated as Tier 2 capital. Tier 2 is designated as the second or supplementary layer of a bank's capital and is less liquid than Tier 1 capital.
Undisclosed reserves are included in Tier 2 capital and will occur through provisions or when a bank charges expenses against a P&L. These items are not disclosed and not visible on public statements, such as the balance sheet. Tier 2 capital, or supplementary capital, also includes a number of important and legitimate constituents of a bank's capital requirement. Five items can typically be included in Tier 2 capital calculations:
- Undisclosed reserves
- Revaluation reserves
- General loan-loss reserves
- Hybrid debt-equity capital instruments
- Subordinated term debt
Tier 1 capital, which is also known as core capital, is more liquid and consists of equity capital and disclosed reserves (e.g. retained earnings). Tier 1 capital is the money the bank has on its books while it undertakes lending, investing, trading, or other risky transactions. Simply put, Tier 1 funds support banks when losses are absorbed so that business functions do not have to be shut down.
Tier 1 and Tier 2 capital requirements were largely standardized in the Basel I accord, issued by the Basel Committee on Banking Supervision and left untouched by the Basel II accord. National regulators of most countries around the world have implemented Tier 2 standards in local legislation. In the calculation of regulatory capital, Tier 2 is limited to 100% of Tier 1 capital.
Undisclosed Reserves Special Considerations
Preferred or accepted forms of capital and collateral have grown in importance, particularly after the banking crisis during 2008 and 2009. Bank stress tests, which were conducted in response to numerous taxpayer-funded bailout programs, highlighted how certain assets and reserves were woefully inadequate during the volatile markets of the Great Recession.
In practice, undisclosed reserves are not common but are accepted by some regulators where a bank has made a profit, but the profit has not appeared in normal retained earnings or in general reserves of the bank. It is fairly standard for undisclosed reserves to be accepted by a bank's supervisory authorities. However, many countries do not accept undisclosed reserves as an accounting concept or even as a legitimate form of capital.