Tier 2 capital, or supplementary capital, includes a number of important and legitimate constituents of a bank's

capital requirement A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital ...

.Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version
/ref>By definition of

Bank for International Settlements The Bank for International Settlements (BIS) is an international financial institution owned by central banks that "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work thr ...

. These forms of banking capital were largely standardized in the

Basel I Basel I is the first Basel Accord. It arose from deliberations by central bankers from major countries during the late 1970s and 1980s. In 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of minimum ...

accord, issued by the

Basel Committee on Banking Supervision The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten (G10) countries in 1974. The committee expanded its membership in 2009 a ...

and left untouched by the

Basel II Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. It is now extended and partially superseded by Basel III. The Basel II Accord was publ ...

accord. National regulators of most countries around the world have implemented these standards in local legislation. In the calculation of

regulatory capital A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital ...

, Tier 2 is limited to 100% of

Tier 1 capital Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view.By definition of Bank for International Settlements. It is composed of ''core capital'', which consists primarily of common stock and disclosed res ...

Undisclosed reserves

Undisclosed reserves are not common, but are accepted by some regulators where a bank has made a profit but the profit has not appeared in normal retained profits or in general reserves of the bank. Undisclosed reserves must be accepted by the bank's supervisory authorities. Many countries do not accept undisclosed reserves as an accounting concept or as a legitimate form of capital.

Revaluation reserves

A revaluation reserve is a reserve created when a company has an asset revalued and an increase in value is brought to account. A simple example is the situation where a bank owns the land and building of its head-offices and bought the properties for $100 a century ago. A current revaluation is likely to reflect a large increase in value. The increase would be added to a revaluation reserve. The reserve may arise out of a formal revaluation carried through to the bank's balance sheet, or a notional addition due to holding securities in the balance sheet valued at historic cost.

also requires that the difference between the historic cost and the actual value be discounted by 55% when using these reserves to calculate Tier 2 capital.

General provisions

A general provision is created against losses which have not yet been identified. The provision qualifies for inclusion in Tier 2 capital as long it is not created against a known deterioration in value. The general provision is limited to *1.25% of RWA (Risk-weighted assets) for banks using the standardized approach *0.6% of credit risk-weighted assets for banks using the IRB approach

Hybrid instruments

Hybrids are instruments that have some characteristics of both

debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...

and equity. Provided these are close to equity in nature, in that they are able to take losses on the face value without triggering a liquidation of the bank, they may be counted as capital. Perpetual

preferred stock Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt inst ...

s carrying a cumulative fixed charge are hybrid instruments. Cumulative perpetual preferred stocks are excluded from Tier 1.

Subordinated term debt

Subordinated debt In finance, subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts if a company falls into liquidation or bankruptcy. Such debt is referred to as 'subordi ...

is debt that ranks lower than ordinary depositors of the bank. Only those with a minimum original term to maturity of five years can be included in the calculation of this form of capital; they must be subject to proper amortization arrangements.

Notes

References

External links

Practical articles, on BIS2 and risk modelling, submitted by professionals to help create an industry standard

FDIC tutorial

FIDC capital
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