Tier 2 Capital
Tier 2 capital is supplementary regulatory capital that absorbs losses in the event of a bank’s failure.
Meaning in Practice
Tier 2 capital includes subordinated debt, hybrid instruments, and general loan-loss reserves that meet regulatory criteria. It ranks below Tier 1 capital in terms of loss absorption and repayment priority. Regulators limit how much Tier 2 capital can count toward a bank’s total capital requirements.
Why It Matters
Tier 2 capital strengthens a bank’s overall capital structure and enhances resilience during financial stress. While it does not provide the same loss-absorbing capacity as core equity, it acts as an additional buffer. Adequate capital levels are essential for maintaining confidence in the banking system.
Market Impact
Changes in capital requirements can affect banks’ funding strategies and issuance of subordinated debt. Strong capital buffers typically reduce perceived credit risk and funding costs. Weak capital positions can lead to rating downgrades, higher borrowing costs, and tighter lending conditions.
Example
A bank issues long-term subordinated bonds that qualify as Tier 2 capital under regulatory rules, thereby increasing its total capital ratio without issuing new equity.