Tier 1 Capital

What is Tier 1 Capital?

Tier 1 capital is a bank’s core capital used to absorb losses and support ongoing operations. It primarily consists of high-quality equity instruments and disclosed reserves that regulators treat as the first line of defense against insolvency.

Key components:
* Common Equity Tier 1 (CET1): common shares, paid-in surplus, retained earnings, certain reserves and qualifying minority interest (after regulatory deductions). CET1 is the highest-quality capital and absorbs losses immediately.
* Additional Tier 1 (AT1): instruments such as noncumulative, nonredeemable preferred stock and other loss-absorbing securities that qualify as Tier 1 but not as CET1.

Tier 1 capital ratio = Tier 1 capital ÷ Risk-weighted assets (RWAs). Regulators set minimum ratios to ensure banks can withstand shocks.

Why Tier 1 Capital matters

• It measures a bank’s ability to absorb unexpected losses without interrupting operations.
• It determines regulatory capital adequacy and affects a bank’s capacity to lend, expand, or raise additional capital.
• Strong Tier 1 buffers build confidence among depositors, creditors, and markets.

Tier 1 vs. Tier 2 Capital

• Purpose:
• Tier 1 (going-concern capital) — supports continued operation by absorbing losses while the bank remains solvent.
• Tier 2 (gone-concern capital) — available in failure scenarios to cover obligations before depositors and senior creditors are affected.
• Composition:
• Tier 1: CET1 + AT1 (equity and loss-absorbing instruments).
• Tier 2: subordinated debt, certain loan-loss provisions, revaluation reserves, hybrid instruments.
• Liquidity and quality: Tier 1 is higher quality and more readily available to absorb losses than Tier 2.

Regulatory minimums and evolution

• Basel I introduced an overall capital-to-RWA minimum of 8%.
• Basel III (post-2007–08 reforms) introduced stricter standards and distinguished CET1 and AT1:
• CET1 minimum: 4.5% of RWAs
• Tier 1 minimum (CET1 + AT1): 6% of RWAs
• Total capital (Tier 1 + Tier 2) minimum: 8% of RWAs
• Basel IV (standards finalized in 2017 and phased in starting January 2023) refines risk calculations for credit, market, and operational risk and tightens some leverage and capital measurement rules. Implementation details and additional buffers vary by jurisdiction.

How banks use Tier 1 capital

Banks maintain Tier 1 capital to:
* Absorb losses and remain solvent during stress events.
* Satisfy regulatory capital requirements and avoid supervisory actions.
* Support business activities (lending, trading, investments) while ensuring financial resilience.

Common questions

What’s the difference between Tier 1 and CET1?
* CET1 is the highest-quality portion of Tier 1 and includes common equity and retained earnings. Tier 1 also includes AT1 instruments that can absorb losses but are not CET1.

Do all countries apply Basel rules the same way?
* No. Basel sets international standards, but national regulators implement and adapt them to local conditions. Buffer requirements and transition timetables can differ.

What changed with Basel IV?
* Basel IV primarily fine-tuned risk-weight calculations, improved operational risk and market risk frameworks, and adjusted leverage measures. The aim was more consistent and risk-sensitive capital requirements across banks and jurisdictions.

Bottom line

Tier 1 capital is the core measure of a bank’s financial strength and resilience. CET1 forms the foundation of Tier 1, while AT1 adds additional loss-absorbing capacity. Regulatory frameworks (Basel III and subsequent refinements) set minimum ratios and continue to evolve to strengthen the banking system’s ability to withstand shocks.