From CUP resources:What is it?A bank’s assets can be categorised according to how risky they are. Tier 1 capital is considered the least risky, followed by less reliable capital in tier 2. A bank with high tier 1 capital is considered more stable (from a regulator’s perspective), better able to sustain future losses and less likely to collapse. Tier 1 capital includes equity capital (= money invested by shareholders, which the shareholders cannot withdraw at will) and disclosed reserves (= the bank’s own money). The bank itself has complete control over both equity capital and disclosed reserves, so there is no risk of unpleasant surprises.Why is it in the news?Governments around the world are currently attempting to reduce the riskiness of their banks, in order to avoid the need for future bailouts from public finances. This means banks will be expected to hold much more tier 1 capital than before. At the G20 meeting in Toronto, leaders pledged that “the quality of capital will be significantly improved to reinforce banks' ability to absorb losses”. The ratio of a bank’s core tier one capital to its risk-weighted assets, which is currently 2 per cent, is expected to double and could rise further. In some countries, such as the UK, there will be a new banking levy, but Tier 1 capital will be exempt from the tax.ReadingThe BIS press release (last link below) spells out the requirements for capital to be included in Tier 1. Although it is a short press release, it contains large amounts of financial jargon.DiscussionWhy are governments so keen to improve the quality of banks’ capital? What is the best way to achieve this? Will the current measures work? What will be negative impact (on banks, on borrowers, etc.) when banks have to hold more safe capital? Where can I read about it?
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Thursday 11 November 2010
Unit 8 Banking: Tier 1 capital
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