The Tier 1 capital ratio is the ratio of a bank's core
equity capital to its total
risk-weighted assets (RWA). Risk-weighted assets are the total of all assets held by the bank weighted by
credit risk according to a formula determined by the Regulator (usually the country's
central bank). Most central banks follow the
Basel Committee on Banking Supervision (BCBS) guidelines in setting formulae for asset risk weights. Assets like
cash and
currency usually have zero risk weight, while certain loans have a risk weight at 100% of their face value. The BCBS is a part of the
Bank of International Settlements (BIS). Under BCBS guidelines total RWA is not limited to Credit Risk. It contains components for
Market Risk (typically based on
value at risk (VAR) ) and
Operational Risk. The BCBS rules for calculation of the components of total RWA have seen a number of changes following the
2008 financial crisis. As an example, assume a bank with $2 of equity lends out $10 to a client. Assuming that the loan, now a $10 asset on the bank's balance sheet, carries a risk weighting of 90%, the bank now holds risk-weighted assets of $9 ($10 × 90%). Using the original equity of $2, the bank's Tier 1 ratio is calculated to be $2/$9 or 22%. There are two conventions for calculating and quoting the Tier 1 capital ratio: • Tier 1 common capital ratio and • Tier 1 total capital ratio Non-redeemable, non-cumulative
preferred shares and non-controlling interests are included in the Tier 1 total capital ratio but not the Tier 1 common ratio. As a result, the common ratio will always be less than or equal to the total capital ratio. In the example above, the two ratios are the same. == See also ==