Tier 2 capital
Encyclopedia
Tier 2 capital, or supplementary capital, include a number of important and legitimate constituents of a bank's capital base . These forms of banking capital 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 these standards in local legislation. In the calculation of regulatory capital
, Tier 2 is limited to 100% of Tier 1 capital
.
also requires that the difference between the historic cost and the actual value be discounted by 55% when using these reserves to calculate Tier 2 capital.
and equity
. Provided these are close to equity in nature, in that they are able to take losses on the face value without triggering a liquidation
of the bank, they may be counted as capital. Perpetual preferred stock
s carrying a cumulative fixed charge are hybrid instruments.
is debt that ranks lower than ordinary depositors of the bank. Only those with a minimum original term to maturity of five years can be included in the calculation of this form of capital; they must be subject to proper amortization arrangements.
Basel I
Basel I is the round of deliberations by central bankers from around the world, and in 1988, the Basel Committee in Basel, Switzerland, published a set of minimal capital requirements for banks. This is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten countries...
accord, issued by the Basel Committee on Banking Supervision
Basel Committee on Banking Supervision
The Basel Committee on Banking Supervision is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1975. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance...
and left untouched by the Basel II
Basel II
Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...
accord. National regulators of most countries around the world have implemented these standards in local legislation. In the calculation of regulatory capital
Capital requirement
Capital requirement refers to -The standardized requirements in place for banks and other depository institutions, which determines how much capital is required to be held for a certain level of assets through regulatory agencies such as the Bank for International Settlements, Federal Deposit...
, Tier 2 is limited to 100% of Tier 1 capital
Tier 1 capital
Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves , but may also include non-redeemable non-cumulative preferred stock...
.
Undisclosed Reserves
Undisclosed reserves are not common, but are accepted by some regulators where a bank has made a profit but this has not appeared in normal retained profits or in general reserves of the bank. They must be accepted by the bank's supervisory authorities. Many countries do not accept this as an accounting concept or a legitimate form of capital.Revaluation Reserves
A revaluation reserve is a reserve created when a company has an asset revalued and an increase in value is brought to account. A simple example may be where a bank owns the land and building of its head-offices and bought them for $100 a century ago. A current revaluation is very likely to show a large increase in value. The increase would be added to a revaluation reserve. The reserve may arise out of a formal revaluation carried through to the bank's balance sheet, or a notional addition due to holding securities in the balance sheet valued at historic cost. Basel IIBasel II
Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...
also requires that the difference between the historic cost and the actual value be discounted by 55% when using these reserves to calculate Tier 2 capital.
General Provisions
A general provision is created against losses which have not yet been identified. They qualify for inclusion in Tier 2 capital as long as they are not created against a known deterioration in value. They are limited to- 1.25% of RWARisk-weighted assetRisk-weighted asset is a bank's assets or off-balance sheet exposures, weighted according to risk. This sort of asset calculation is used in determining the capital requirement or Capital Adequacy Ratio for a financial institution...
for banks using the standardized approachStandardized approach (credit risk)The term standardized approach refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions.... - 0.6% of credit risk-weighted assets for banks using the IRBAdvanced IRBThe term Advanced IRB or A-IRB is an abbreviation of advanced internal ratings-based approach and it refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions....
approach
Hybrid Instruments
Hybrids are instruments that have some characteristics of both debtDebt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
and equity
Equity (finance)
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
. Provided these are close to equity in nature, in that they are able to take losses on the face value without triggering a liquidation
Liquidation
In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation...
of the bank, they may be counted as capital. Perpetual preferred stock
Preferred stock
Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...
s carrying a cumulative fixed charge are hybrid instruments.
Subordinated Term Debt
Subordinated debtSubordinated debt
In finance, subordinated debt is debt which ranks after other debts should a company fall into receivership or bankruptcy....
is debt that ranks lower than ordinary depositors of the bank. Only those with a minimum original term to maturity of five years can be included in the calculation of this form of capital; they must be subject to proper amortization arrangements.