Tier 2 capital

Indian Economy glossary

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

Meaning

Tier 2 capital is the lower-quality part of a bank's capital. Capital is the owners' own money, and it absorbs losses before depositors lose anything. Tier 2 is called gone-concern capital because it absorbs losses mainly when a bank is wound up (liquidated), not while it keeps running. It includes:

  • subordinated debt, which is repaid only after depositors and other senior creditors
  • general provisions, up to 1.25% of credit risk-weighted assets
  • revaluation reserves, counted at a discount

It is part of the capital adequacy ratio (CRAR) = (Tier 1 + Tier 2) ÷ Risk-weighted assets. RBI sets the minimum CRAR at 9%, against 8% under Basel III.

Example

A bank's credit risk-weighted assets are Rs 1,000 crore, and it holds Rs 20 crore of general provisions. Only Rs 12.5 crore (1.25% of Rs 1,000 crore) can count as Tier 2 capital. The other Rs 7.5 crore does not count towards CRAR.

Don't confuse with

  • Tier 1 capital: this is going-concern capital. It is made up of CET1 (common shares, retained earnings) and AT1, and it absorbs losses while the bank is still running. "Tier 2 is going-concern capital" is a common Prelims trap, and it is false.

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