Tier 1 Capital
Tier 1 capital is a bank’s core capital consisting primarily of common equity and disclosed reserves used to absorb losses.
Meaning in Practice
In practice, Tier 1 capital includes common shares, retained earnings, and certain additional instruments that meet strict regulatory criteria. It represents the highest quality capital because it is fully available to cover losses while the bank remains a going concern. Regulators use Tier 1 capital to assess a bank’s financial strength and resilience.
Why It Matters
Tier 1 capital is central to maintaining confidence in the banking system. A strong Tier 1 capital position allows banks to withstand economic shocks and unexpected losses. It also determines how much risk-weighted exposure a bank can safely hold.
Market Impact
Higher Tier 1 capital ratios generally improve investor confidence and reduce funding costs. Weak capital levels can trigger regulatory intervention, credit rating downgrades, or restrictions on dividends. Capital strengthening measures may dilute shareholders but enhance long-term stability.
Example
If a bank incurs significant loan losses during a recession, those losses are first absorbed by its retained earnings and common equity, both components of Tier 1 capital.