Tier 1 Capital

Banking regulations divide capital into tiers according to how reliably it can absorb losses. Tier 1 capital is the strongest.

The core part, often called Common Equity Tier 1, includes ordinary shares and retained earnings, after deductions for items such as goodwill and certain other intangible assets that might not hold their value in a crisis. Tier 1 can also include some other instruments that are permanent and can absorb losses, such as certain types of perpetual bonds that can be written down or converted into shares.

For example, a bank with 50 million of ordinary share capital and 30 million of retained earnings, minus 10 million of goodwill, would have core Tier 1 capital of about 70 million.

Regulators set minimum Tier 1 ratios, comparing Tier 1 capital with risk-weighted assets. Because Tier 1 capital is permanent and does not need to be repaid, it gives the bank the ability to absorb losses without failing. It is the measure regulators and investors focus on most when judging a bank's financial strength.