Question

Regulators treat Tier I capital differently from Tier II capital? What is the difference and why are they treated differently?

Answer 1

Regulators treat Tier I capital differently from Tier II capital?

According to Basel norms,

Bank capital consist of tier 1 & tier 2 capital and both of them are different.

Tier 1 capital consist of bank’s core capital (shareholder's equity and retained earnings) and,

Tier 2 capital consist of supplementary capital, by adding these we can calculate the Capital adequeacy ratio.

Tier 1 capital mainly consist of paid up capital, disclosed reserves, capital reserves, investment fluctuation reserves.

Tier 2 capital consist of mainly Undisclosed reserves, revaluation reserve, provision and loss reserve, hybrid debt capital such as bonds, unsecured loans longer term, debt capital securities

Regulators treat tier 1 & 2 capital differently because,

If a bank loses tier 1 capital their business will not be halted, but if you are start losing tier 2 capital then your bank will be going to insolvent

Tier 1 capital is more liquid and reliable

So basically If a bank is in trouble or hit by a scam or any financial deteriotation then first it's tier capital will be hit, if tier 1 capital is sufficient then the bank will be safe.

So according to basel 3 norms Tier 1 capital should be 10.5 %

Basically Tier 1 capital is nothing but equity so in bad financial circumstances Bank will first lose it's equity.

Tier 2 capital consist mainly of debt.