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TIER ONE CAPITAL

Today, we but pause for a bit to discuss something a little different from our usual real estate and allied topics - TIER ONE CAPITAL.

My good friend of about 10 years called my cell this morning to pick my brains on the basic difference between Tier One and Tier Two Capital owing to the fact that he knows that I wear another hat with roots in the Financial Services Industry. Within 3 minutes of talk he understood clearly what they are but I’m moved to sharing our conversation with our teeming bloggers (you never who’s going to learn something new). Here we go -

TIER ONE CAPITAL
This is one of the two categories into which a bank's capital is divided, consisting of the most central and important types of capital. According to banking rules, banks must keep a certain amount of tier one capital to protect them against failing. Tier one capital is the best form of bank capital - the money that the bank has in its coffers to support all the risks it takes: lending, trading and so on.

Under capital adequacy regulations meant to ensure banks keep enough money on hand, tier one capital is core capital that is relatively transparent and secure (comprising equity capital and disclosed reserves), while tier two capital is supplementary capital that is more complex and variable (such as loan loss provisions and subordinated debt).

Example
In recent years, tier one rules have been loosened to allow in less top-notch capital, such as hybrid debt. Hybrid - a halfway house between debt and equity - was issued in massive amounts, particularly by European banks, in recent years as a means to gear up in size without damaging credit ratings, or diluting shareholders.


Of course, such a dreamy instrument turned into a nightmare when the financial crisis hit, with hybrids unable to absorb losses, as at Northern Rock, the failed British lender. Regulators now want to do away with hybrids, restricting tier one capital largely to equity and retained profits, both of which can be eaten into in an emergency.

 Ken Egedi

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