Tier 1 Capital Ratio

What it is

The Tier 1 capital ratio measures a bank’s core financial strength by comparing its highest-quality capital to its risk-weighted assets. Regulators use it to assess whether a bank has enough capital to absorb losses and remain solvent during stress.

Tier 1 capital — what’s included

Tier 1 (core) capital typically consists of:
* Common equity (common stock and paid-in capital)
* Retained earnings
* Accumulated other comprehensive income (AOCI)
* Certain noncumulative perpetual preferred stock
* Regulatory adjustments required by supervisors

It does not include customer deposits.

Formula

Tier 1 Capital Ratio = Tier 1 Capital ÷ Total Risk‑Weighted Assets

Example: if Tier 1 capital = $5 million and risk‑weighted assets = $50 million, the ratio = 10%.

Risk‑weighted assets (RWAs)

RWAs reflect the credit risk of a bank’s assets by assigning weights to different asset classes:
* Cash and sovereign securities often carry a 0% weight.
* Mortgages, corporate loans and other assets receive higher weights (e.g., 20%, 50%, 100%) depending on their risk.
Regulatory frameworks define the weighting rules used to calculate total RWAs.

Regulatory context and minimums

Basel III tightened capital and RWA standards to ensure banks hold larger equity buffers. Key minimums under Basel III include:
* Common equity tier 1 (CET1) — at least 4.5% of RWAs
* Tier 1 capital ratio — at least 6% of RWAs
* Leverage ratio (non‑risk measure) — at least 3% of total assets (higher for systemically important banks)

These minimums may be supplemented by additional buffers and national requirements.

How the ratio is used

• Supervisors gauge a bank’s ability to withstand losses and continue operations.
• Investors and counterparties use it to compare capitalization across institutions.
• A higher ratio indicates a larger cushion to absorb losses; a low ratio can limit a bank’s activities or trigger supervisory action.

Related ratios

• Tier 1 Common (CET1) Ratio — focuses on common equity only (excludes preferred stock and non‑controlling interests). It is a stricter measure of loss‑absorbing capital.
• Tier 1 Leverage Ratio — Tier 1 capital divided by average total consolidated assets (and certain off‑balance sheet exposures). It is not risk‑weighted and caps leverage regardless of asset risk.

Examples

• Bank A: Tier 1 capital $5m, RWAs $50m → ratio = 10% (well above minimum).
• Bank B: Tier 1 capital $1m, RWAs $25m → ratio = 4% (below the 6% minimum — undercapitalized).
• Bank C: Tier 1 capital $5m, RWAs $83.33m → ratio = 6% (meets the minimum).

FAQs

Q: What’s the difference between Tier 1 and Tier 2 capital?
A: Tier 1 is core capital (equity, retained earnings). Tier 2 is supplementary capital (subordinated debt, hybrid instruments, certain reserves) and is considered less loss‑absorbing.

Q: Is a higher Tier 1 capital ratio better?
A: Generally yes — a higher ratio means more capacity to absorb losses and lower insolvency risk. Regulators require minimums (e.g., 6% for Tier 1), and many banks maintain higher ratios for safety and market confidence.

Bottom line

The Tier 1 capital ratio is a central measure of a bank’s financial resilience. It compares high‑quality capital to the riskiness of assets and is used by regulators, investors, and counterparties to judge whether a bank has sufficient capital buffers. Under Basel III, banks must meet minimum Tier 1 and CET1 thresholds to reduce the likelihood of failure in times of stress.