Tier 1 Capital

Tier 1 Capital is the core capital of a bank, representing its most stable and loss-absorbing financial resources. It is the primary measure of a bank’s financial strength and is the foundation of the Capital Adequacy Ratio framework under Basel norms.

What Is Tier 1 Capital?

Tier 1 Capital consists of:

**Common Equity Tier 1 (CET1):**
– Paid-up share capital (equity)
– Share premium (amount received above face value)
– Retained earnings and reserves
– Accumulated other comprehensive income

**Additional Tier 1 (AT1):**
– Perpetual bonds that can absorb losses (AT1 bonds)
– Instruments with no maturity date that convert to equity or are written down under specified stress conditions

Tier 1 Capital must be at least 6% of Risk-Weighted Assets under Basel III, of which CET1 must be at least 4.5%.

Why Tier 1 Capital Is Important

Tier 1 capital is the “going concern” capital. It absorbs losses while the bank continues to operate, protecting depositors and the financial system without needing government intervention.

Unlike Tier 2 capital, Tier 1 capital is permanently available, with no maturity and no requirement to pay distributions if the bank is in stress.

AT1 Bonds: A Risk Instrument

AT1 (Additional Tier 1) bonds are a form of perpetual debt that counts as Tier 1 capital. They:
– Pay interest as long as the bank is profitable
– Interest can be skipped if the bank’s capital falls below a threshold
– Can be permanently written down or converted to equity under stress
– Are not guaranteed; investors take equity-like risk

The Yes Bank crisis of 2020 saw AT1 bonds worth Rs 8,415 crore written off to zero, causing large losses for retail investors who had bought them expecting bond-like safety.

Practical Example

Bank A has equity capital of Rs 1,000 crore, retained earnings of Rs 300 crore, and has issued AT1 bonds of Rs 200 crore. Tier 1 Capital = Rs 1,000 + Rs 300 + Rs 200 = Rs 1,500 crore. With risk-weighted assets of Rs 15,000 crore, Tier 1 CAR = 10%.

Key Takeaways

– Tier 1 Capital is a bank’s core equity and equivalent instruments; the primary loss absorber
– Consists of Common Equity Tier 1 (CET1) and Additional Tier 1 (AT1) components
– Under Basel III/RBI, Tier 1 CAR must be at least 6% of Risk-Weighted Assets
– AT1 bonds can be written off or converted to equity in stress; retail investors should understand this risk
– Higher Tier 1 Capital means stronger financial position and lower risk of failure