Tier 2 Capital
IntermediateTier 2 capital is a bank's supplementary capital, made up of instruments such as certain long-term subordinated debt and some loan loss reserves, which absorb losses mainly if the bank fails.
Tier 2 capital is the second layer of a bank's regulatory capital. It is considered lower quality than Tier 1, because it is less permanent and generally absorbs losses only when a bank is being wound up or rescued, rather than while it continues to operate normally.
The main component is usually subordinated debt: long-term bonds that rank behind deposits and ordinary creditors in a bankruptcy. If the bank fails, Tier 2 holders take losses before depositors, protecting them. Certain general loan loss reserves can also count as Tier 2, within limits.
For example, a bank might issue 200 million of ten-year subordinated bonds. Under the rules, these can count towards its Tier 2 capital, although their contribution is reduced as they approach maturity.
Regulators require banks to hold total capital, Tier 1 plus Tier 2, above a minimum share of risk-weighted assets, with most of it in Tier 1. Tier 2 provides an extra cushion for depositors and creditors but does not give the same protection as high-quality equity.
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