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Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. [note 1] It is composed of core capital, [1] which consists primarily of common stock and disclosed reserves (or retained earnings), [2] but may also include non-redeemable non-cumulative preferred stock.
Capital adequacy ratio is the ratio which determines the bank's capacity to meet the time liabilities and other risks such as credit risk, operational risk etc. In the most simple formulation, a bank's capital is the "cushion" for potential losses, and protects the bank's depositors and other lenders.
To be well-capitalized under federal bank regulatory agency definitions, a bank holding company must have a Tier 1 capital ratio of at least 6%, a combined Tier 1 and Tier 2 capital ratio of at least 10%, and a leverage ratio of at least 5%, and not be subject to a directive, order, or written agreement to meet and maintain specific capital levels.
Basel III requires banks to have a minimum CET1 ratio (Common Tier 1 capital divided by risk-weighted assets (RWAs)) at all times of: . 4.5%; Plus: A mandatory "capital conservation buffer" or "stress capital buffer requirement", equivalent to at least 2.5% of risk-weighted assets, but could be higher based on results from stress tests, as determined by national regulators.
According to the draft guidelines published by RBI the capital ratios are set to become: Common Equity as 5% + 2.5% (Capital Conservation Buffer) + 0–2.5% (Counter Cyclical Buffer), 7% of Tier 1 capital and minimum capital adequacy ratio (excluding Capital Conservation Buffer) of 9% of Risk Weighted Assets.
The total capital ratio requirements towards D-SIBs, will be stricter than the minimum 10.5% required by Basel III towards all normal sized financial institutions, which comprise a requirement of: max. 2% Tier 2 capital (Subordinated capital). max. 1.5% Additional Tier 1 capital (Hybrid capital, i.e. Contingent Convertibles aka CoCos).
The term standardized approach (or standardised approach) refers to a set of credit risk measurement techniques proposed under Basel II, which sets capital adequacy rules for banking institutions. Under this approach the banks are required to use ratings from external credit rating agencies to quantify required capital for credit risk. In many ...
Supervisory review of an institution's capital adequacy and internal assessment process; Effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices. Capital requirements for operational risk were introduced for the first time. The ratio of equity and credit is 8% under Basel II. The standards ...