Regulators use the Tier 1 capital ratio to determine whether a bank is well capitalized, undercapitalized or sufficiently capitalized relative to the minimum requirement. The Tier 1 capital ratio is the ratio of a bank`s core equity to its total risk-weighted assets (RWA). Risk-weighted assets are the sum of all assets held by the bank, weighted by credit risk according to a formula established by the regulator (usually the country`s central bank). Most central banks follow the guidance of the Basel Committee on Banking Supervision (BCBS) when establishing asset risk weighting formulas. Assets such as cash and currencies typically do not have a risk weighting, while some loans have a risk weighting of 100% of their face value. BCBS is part of the Bank for International Settlements (BIS). According to the BCBS guidelines, total RWA is not limited to credit risk. It includes components for market risk (usually based on value at risk (VAR)) and operational risk. The BCBS rules for calculating the components of the RWA as a whole underwent a number of changes as a result of the 2007-2008 financial crisis.
[3] a) Calculation of regulatory capital ratios. The regulatory capital ratios of an institution in the system are determined on the basis of the institution`s financial statements prepared in accordance with GAAP using the average daily balances of the last 3 months. (ii) To calculate the measure of ERU and URE equivalents described in paragraph (b)(4) of this Section, an institution in the system shall adjust the ERUs and URE equivalents to reflect all deductions and adjustments required under Article 628.22(a), (b) and (c) and (c) and use the denominator of the Tier 1 leverage ratio. (c) the calculation of the own funds ratio. The regulatory capital ratios of a system institution are as follows: The Tier 1 capital ratio can be expressed as a bank`s total core capital or as a common equity ratio 1 or CET1 ratio. The CET1 ratio excludes preferred shares and non-controlling interests in the total amount of Tier 1 principal; Therefore, it is always less than or equal to the total capital ratio. The Basel III standards led to the tightening of Tier 1 capital requirements and the introduction of the Tier 1 leverage ratio to avoid excessive debt accumulation and increase banks` capital ability to amortize potential losses in their exposures. A stronger Tier 1 capital ratio suggests a better ability of the bank to absorb losses. Therefore, as a general rule, the higher the ratio, especially the CET1 capital ratio, the better. (5) Permanent capital ratio.The permanent own funds ratio of an institution in the system is the ratio of the institution`s permanent capital to its total risk-adjusted assets, as set out in the institution`s call report, calculated in accordance with the rules set out in Subsection H of Part 615 of this Chapter. (4) A Tier 1 leverage ratio of 4 %, of which at least 1,5 % is composed of ERUs and URE equivalents. From the perspective of a supervisor, Tier 1 capital is the key measure of a bank`s financial soundness. [Note 1] It consists of core equity[1], which consists mainly of common shares and disclosed reserves (or retained earnings)[2], but may also include non-refundable and non-cumulative preferred shares. The Basel Committee also noted that over the years, banks have used innovative tools to generate Tier 1 capital; These are subject to strict conditions and are limited to a maximum of 15% of the total Tier 1 capital. This Tier 1 portion of the capital will expire as part of the implementation of Basel III. (b) minimum own funds requirements. An institution in the system must meet the following minimum capital ratios: Basel III has tightened the capital requirements that banks must comply with.
The agreement classifies regulatory capital into Tier 1 and Tier 2 capital. Tier 1 includes Common Equity Tier 1 and other Tier 2 capital. Common equity Tier 1 includes instruments with discretionary dividends, such as common shares, while additional Tier 1 capital includes non-term instruments whose dividends can be cancelled at any time. Capital in this sense refers to the accounting concept of equity, but differs from it. Tier 1 and Tier 2 capital was first defined in the Basel I Equity Accord and remained essentially the same. Tier 2 capital represents “additional capital” such as undisclosed reserves, revaluation reserves, general provisions for risks, hybrid equity instruments (debt/equity) and subordinated debt instruments. The Tier 1 capital ratio was introduced in 2010 after the financial crisis as a measure of a bank`s ability to withstand financial difficulties.
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