Tier 1 capital

Also called: Core capital, Going-concern capital · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

Tier 1 capital is a bank's best-quality capital. It is made of Common Equity Tier 1 (CET1), such as shares and past profits kept in the bank, plus Additional Tier 1 (AT1) instruments, which are perpetual bonds that can be written down or turned into shares. It is called "going-concern" capital because it absorbs losses while the bank keeps running, before any depositor is hurt.

Tier 1 capital = CET1 + AT1

It matters because it is the first shield against bad loans. The RBI's two key safety ratios, the Tier 1 ratio and the leverage ratio, are both built on it.

Explanation

How it works: the first cushion

• A bank's capital is the owners' own money, not borrowed money. It works like net worth: Assets − Liabilities.
• Going-concern means the bank takes the loss and still stays open.
• A loan goes bad, so the bank's assets fall.
• Tier 1 capital shrinks to cover the loss.

• Depositors are still paid in full, and the bank keeps lending.

• Tier 2 capital is different. It is "gone-concern" capital and absorbs losses mainly when the bank is wound up (liquidation).

• Why banks need it: banks run on leverage, meaning they buy assets mostly with borrowed money (deposits).
• Suppose a bank has Rs 100 of assets and Rs 8 of capital. An 8% loss wipes out all its capital, and the bank becomes insolvent (it owes more than it owns).
• With Rs 12 of capital, the same loss leaves Rs 4, and the bank survives.

The two parts of Tier 1

• Common Equity Tier 1 (CET1): the purest capital
• common shares
• share premium (money paid above the face value of shares)
• retained earnings (past profits kept in the bank)

• disclosed reserves

• Additional Tier 1 (AT1) instruments

• They are perpetual, meaning they have no maturity date and the bank never has to repay them.
• They are non-cumulative, meaning any interest the bank skips is never paid later.

• They are written down or converted into equity in two cases:

  • CET1 falls below a set trigger
  • the bank reaches the point of non-viability (PONV), when the regulator decides the bank cannot survive without help

• What is NOT in Tier 1:

• subordinated debt (paid back only after depositors and other creditors)
• general provisions
• revaluation reserves (gains from revaluing property)
• All three count in Tier 2.

What makes Tier 1 rise or fall

• It rises when:
• the bank keeps profits instead of paying them out as dividends
• the bank issues new shares or AT1 bonds

• the government puts in fresh capital (recapitalisation of PSBs)

• It falls when:

• the bank makes losses, for example when it sets aside money for bad loans (NPAs)

• AT1 bonds are written down

• The ratio also falls when risk-weighted assets grow faster than capital. For example, fast growth in loans with high risk weights, like unsecured personal loans, pushes the ratio down.

Worked example

Say a bank has risk-weighted assets (RWA) of Rs 440. RWA means each asset multiplied by its risk weight, all added together. G-secs carry 0%, home loans carry a low weight and corporate loans carry 100%. The bank's total assets are Rs 1,000.

Item	Rs	Ratio
CET1	30	30 ÷ 440 ≈ 6.8%
AT1	5
Tier 1	35	35 ÷ 440 ≈ 7.95%
Tier 2	15
Total capital	50	CRAR = 50 ÷ 440 ≈ 11.4%

• Tier 1 ratio: 7.95% is above India's 7% minimum, so the bank passes.
• CET1: 6.8% is above the 5.5% minimum but below the 8% needed once the conservation buffer is added. So the bank faces limits on dividends.
• Leverage ratio: Tier 1 ÷ total exposure = 35 ÷ 1,000 = 3.5%.
• This just meets the 3.5% minimum for ordinary banks.
• It fails the 4% minimum for D-SIBs.

In India

• Regulator: the RBI turns the Basel III norms into binding rules for Indian banks. Basel III is the post-2008 set of global bank rules made by the Basel Committee on Banking Supervision (BCBS), and the norms are not binding on their own.
• Legal basis: Basel III capital regulations took effect in India from 1 April 2013, and banks must meet them on an ongoing basis. [1] The full phase-in was completed in October 2021.
• Tier 1 capital must be at least 7% of RWA on an ongoing basis. [1] This is stricter than the Basel III level of 6%.

Ratio	Basel III	India (RBI)
CET1	4.5%	5.5%
Tier 1	6%	7%
Total CRAR	8%	9%
CET1 + capital conservation buffer	7%	8%
Leverage ratio (Tier 1 ÷ total exposure)	3%	4% (D-SIBs), 3.5% (others)

• Buffers are extra. The RBI's definition of CET1 does not include the capital conservation buffer or the countercyclical capital buffer. These buffers are held on top of the minimum CET1. [1]
• Latest position: the CET1 ratio of scheduled commercial banks rose from 9.98% (March 2015) to 14.81% (March 2025), and total CRAR reached 17.36% (March 2025). [3]
• Stress tests are the RBI's simulations of a bad economy. They show banks' total capital staying above the regulatory minimum even in adverse scenarios (Financial Stability Report, June 2026). [2]
• Why Tier 1 improved: government recapitalisation of PSBs, the NPA clean-up after the Asset Quality Review (2015) and the IBC (2016), and higher profits kept in the banks.

Don't confuse with

• Tier 2 capital: this is gone-concern capital (subordinated debt, general provisions, revaluation reserves). It absorbs losses mainly in liquidation. Tier 1 absorbs losses while the bank is still running.
• CET1: this is only the common-equity part of Tier 1. Tier 1 = CET1 + AT1. India's minimums are CET1 5.5% and Tier 1 7%.
• CRAR (Capital Adequacy Ratio): CRAR = (Tier 1 + Tier 2) ÷ RWA, with a 9% minimum. It uses total capital. The Tier 1 ratio uses only Tier 1.
• Leverage ratio: it uses Tier 1 ÷ total exposure, with no risk weights. It is a simple backstop in case banks show risky assets as safer than they are. Risk-based ratios divide by RWA.

Prelims Hooks

• Tier 1 = CET1 + AT1. It is going-concern capital. Tier 2 is gone-concern capital.
• India's minimum Tier 1 ratio is 7% of RWA (Basel III: 6%). It applies on an ongoing basis. [1]
• Trap: AT1 bonds are Tier 1, not Tier 2. General provisions count in Tier 2 (up to 1.25% of credit RWA), not Tier 1.
• AT1 features: perpetual and non-cumulative. They are written down or converted into equity at a CET1 trigger or at the point of non-viability (PONV).
• The leverage ratio's numerator is Tier 1 capital. The minimum is 4% for D-SIBs and 3.5% for other banks (Basel: 3%).
• Capital conservation buffer (2.5%) must be met with CET1 only. Breaching it limits dividends. It does not shut the bank. The buffer is not part of the minimum CET1. [1]

Mains Points

• Quality over quantity: the 2008 crisis showed that banks held too little capital, and that much of it was of poor quality.
• Basel III made common equity the core of Tier 1.
• India set a higher bar (Tier 1 7%, CET1 5.5%) because PSBs have a history of high NPAs and bank loans are concentrated in a few sectors and companies.

• A good answer should link this to depositor protection and less need for taxpayer bailouts.

• Safety vs growth: equity costs a bank more than deposits.

• PSBs short of Tier 1 capital cut back lending.
• This happened in 2017-18 under Prompt Corrective Action (PCA), the RBI's framework of restrictions on weak banks. Credit to MSMEs was squeezed.

• A good answer weighs the fiscal cost of recapitalisation against the growth cost of tight credit.

• Capital and resolution go together: strong Tier 1 buffers (CET1 14.81%, March 2025) [3] absorb losses, and AQR (2015) and IBC (2016) remove the bad assets. Neither works alone.

• AT1 write-downs show that Tier 1 investors share losses in a crisis.
• This supports market discipline (Basel II's Pillar 3, which requires banks to publish their capital and risk data).

Related concepts

• Leverage
• Basel norms
• Basel I
• Basel II
• Three pillars of Basel
• Capital adequacy ratio
• Risk-weighted assets
• Common Equity Tier 1
• Additional Tier 1 capital
• Tier 2 capital

Read more

• Capital adequacy: Basel I to Basel III