Bank tiers indicate an institution’s financial health. For example, a Tier 1 bank can immediately absorb losses without halting banking operations. A Tier 2 bank or institution with supplementary capital has less secure and harder to liquidate assets, which is less stable during a crisis.
What does Tier 1 bank mean?
The term Tier 1 describes an institution’s core capital or the core asset holdings of a bank. These assets are usually the most stable and liquid assets a bank possesses, with high risk aversion. Tier 1 capital includes shareholder equity and retained earnings. Shareholder equity is what the bank’s assets are worth after settling debts and liabilities. Retained earnings are the net income a bank has over its lifespan after paying out dividends.
These assets are critical to a bank’s longevity because they are public, allowing regulators and investors to evaluate a bank’s financial health. They are also easily convertible into cash, so banks can keep afloat during unexpected financial situations or loss scenarios.
What are some examples of Tier 1 banks?
There are different Tier 1 banks in Europe and the US. In the United States, Tier 1 banks include:
- Bank of America
- J.P. Morgan
- Morgan Stanley
- Wells Fargo
- Goldman Sachs
A few examples of European Tier 1 banks are:
- Credit Suisse
What is the difference between Tier 1 and Tier 2 capital?
Tier 1 and Tier 2 capital describe two types of assets banks hold. Tier 1 capital is a bank’s core capital, which it uses to operate on a daily basis. Tier 2 capital is a bank’s supplementary capital, which is in reserve.
Tier 2 capital includes revaluation reserves, hybrid capital instruments, subordinated term debt, general loan-loss, and undisclosed reserves.
Ultimately, Tier 2 capital is less reliable than Tier 1 capital because it is more difficult to accurately calculate and liquidate.