Tier 1 Common Capital Ratio

Tier 1 Common Capital Ratio — Meaning and Overview

The Tier 1 common capital ratio measures a bank’s core common equity relative to its total risk-weighted assets. It indicates how well a bank can absorb losses and remain solvent under stress. Regulators and investors use this ratio to assess capital adequacy and to determine whether a bank may face restrictions on dividends or share buybacks.

Key points
* Focuses on common equity only — excludes preferred stock and noncontrolling interests.
* Used in regulatory capital assessments and stress tests.
* Influences whether a bank is classified as well-capitalized and whether it can pay dividends or repurchase shares.

Formula

Tier 1 common capital ratio = (Tier 1 capital − Preferred stock − Noncontrolling interests) / Total risk-weighted assets

Where:
* Tier 1 capital = core capital including common equity and disclosed reserves
* Preferred stock = non-common preferred equity
* Noncontrolling interests = equity in subsidiaries not attributable to the parent
* Total risk-weighted assets = assets weighted by credit risk

What the Ratio Shows

Risk-weighted assets (RWAs) reflect the credit risk of different asset classes. Central banks typically assign weights such as:
* 0% for cash and government securities
* 20%, 50%, or 100% for various loan types, depending on credit risk

Regulatory classifications based on the Tier 1 common capital ratio include: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. To be considered well-capitalized, a bank generally needs a Tier 1 common capital ratio of at least 7% and must not pay dividends that would reduce the ratio below that threshold. Systemically important financial institutions (SIFIs) typically face an additional 3% buffer, raising the well-capitalized threshold to about 10%.

The ratio is used in stress tests (for example, by the Federal Reserve) to evaluate whether a bank can withstand economic shocks.

Difference from Tier 1 Capital Ratio

The Tier 1 capital ratio includes Tier 1 capital in total (which may include certain types of preferred stock). The Tier 1 common capital ratio is stricter: it removes preferred stock and noncontrolling interests, leaving only common stock, retained earnings, and other comprehensive income. Because of this exclusion, the Tier 1 common capital ratio is often lower than the standard Tier 1 capital ratio.

Example

Assume:
* Risk-weighted assets = $100 billion
Common stock = $4 billion
Retained earnings = $4 billion
* Preferred stock = $0.5 billion

Tier 1 common capital = common stock + retained earnings = $8 billion
Tier 1 common capital ratio = (8.0 − 0.5) / 100 = 7.5%

If preferred stock were included (Tier 1 capital ratio), the ratio would be 8.0%.

Why Investors and Regulators Care

• Indicates loss-absorbing capacity and resilience to stress.
• Determines regulatory classification and constraints on capital distributions.
• Helps investors assess dividend and buyback prospects, and overall bank solvency.

Takeaways

• The Tier 1 common capital ratio is a conservative measure of a bank’s core equity strength.
• It excludes preferred stock and noncontrolling interests, making it stricter than the Tier 1 capital ratio.
• Regulators use it to classify capital adequacy and enforce restrictions to maintain financial stability.