Tier 1 Capital
Tier 1 capital is a key measure of a banks financial strength from a regulatory perspective. It is composed of core capital, which primarily includes common stock and disclosed reserves, and may also include non-redeemable non-cumulative preferred stock. This capital is used to fund the banks business activities and is essential for the banks daily operations. Tier 1 capital is the primary funding source of the bank and is designed to provide protection against unexpected losses, ensuring that the bank can continue its regular functions without being shut down.
The Basel III accord sets the minimum Tier 1 capital ratio requirement for financial institutions, requiring banks to maintain the equivalent of 6% of their risk-weighted assets in Tier 1 capital. This ensures that banks have enough liquid assets on hand to absorb losses without the risk of bank failure. Common Equity Tier 1 (CET1) and Additional Tier 1 (AT1) are the two components of Tier 1 capital, with CET1 being the highest quality of regulatory capital that absorbs losses immediately when they occur.
In summary, Tier 1 capital is a critical component of a banks financial structure, providing the necessary resources to support its operations and absorb unexpected losses, thereby ensuring its stability and resilience.
