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Arpan Agrawal

Definition

Tier 1 Capital Ratio (%) is a financial metric used to measure the financial health of a bank. It is a measure of core capital, equity and retained earnings (along with disclosed reserves), as a percentage of risk-adjusted assets.

Note that equity capital includes instruments that cannot be redeemed at the option of the security holder (e.g. non-redeemable preferred stock). The metric is primarily used to indicate the ability of the bank (or other institutions that hold reserves) to weather unexpected losses.

Considerations

The components comprising the inputs for the Tier 1 Capital Ratio can vary from country to country, as can the risk-weighting of similar assets. Certain countries may have different legislation for certain asset types, thereby creating variation in how risky they are.

Example

If Country A requires that corporate debtors have more stringent debt covenants than Country B, then corporate bonds will have different risk characteristics between the two countries (i.e. corporate debt in Country A will likely be less risky than in Country B). Investors (and regulators) will need to adjust corporate debt investments accordingly.

Classifications

There are typically five ranking buckets:

1. Well-Capitalized (T1CR > 6%)
2. Adequately Capitalized (4 - 6%)
3. Undercapitalized (3 - 4%)
4. Significantly Undercapitalized (< 4%)
5. Critically Undercapitalized (< 4%)'

Firms ranked Undercapitalized and below are restricted from declaring/issuing dividends and management fees, and must file a capital restoration plan.

Resources

1. http://www.briefing.com/GeneralContent/Investor/Active/ArticlePopup/ArticlePopup.aspx?SiteName=Investor&ArticleId=NS20071102105404AskAnAnalyst
2. http://www.investopedia.com/terms/t/tier1capital.asp
3. http://en.wikipedia.org/wiki/Tier_1_capital