Short answer: Tier 1 capital is a bank's core regulatory capital, primarily common stock, retained earnings, and qualifying perpetual preferred. The Tier 1 capital ratio is Tier 1 capital divided by risk-weighted assets. Under US Prompt Corrective Action rules, a bank is well-capitalized at a Tier 1 ratio of 8% or higher. Most US banks run well above that floor.
What counts as Tier 1 capital?
Tier 1 capital is the slice of a bank's capital structure that absorbs losses first while the bank is still operating (rather than at liquidation). It consists of:
- Common stock issued by the bank.
- Retained earnings accumulated since inception.
- Qualifying additional Tier 1 (AT1) instruments: perpetual non-cumulative preferred stock and similar deeply subordinated instruments. Community banks typically have little or none of this.
- Minus regulatory deductions for things like goodwill, certain deferred tax assets, and investments in unconsolidated financial entities.
Common Equity Tier 1, or CET1, is the highest-quality slice within Tier 1: common stock and retained earnings only, before adding AT1.
The Tier 1 capital ratio formula
Risk-weighted assets (RWA) adjust each asset on the bank's balance sheet by its credit risk. The standardized weights, simplified:
- Cash and US Treasuries: 0%
- Most residential mortgages: 50%
- Most commercial loans: 100%
- Higher-risk exposures: 150% or more
A bank's RWA is usually smaller than its total assets because part of the balance sheet (cash, government securities, GSE-backed mortgages) gets weighted below 100%. So Tier 1 ratios look higher than leverage ratios.
Regulatory thresholds
Under US Prompt Corrective Action rules, banks are classified by their capital ratios. The "well-capitalized" thresholds are:
| Ratio | Well-capitalized minimum |
|---|---|
| CET1 risk-based ratio | 6.5% |
| Tier 1 risk-based ratio | 8.0% |
| Total capital ratio | 10.0% |
| Tier 1 leverage ratio | 5.0% |
In practice, most US community banks operate well above these floors. A Tier 1 ratio between 11% and 14% is common. Anything under 9% is unusual outside a bank actively managing growth, an acquirer absorbing a deal, or an institution under regulatory pressure.
Why Tier 1 is the capital number that matters most
There's also a Tier 2 capital ratio and a Total Capital ratio. Tier 2 includes things like the loan loss reserve up to a cap, qualifying subordinated debt, and certain hybrid instruments. Total Capital is Tier 1 plus Tier 2.
Regulators and analysts focus on Tier 1 (and CET1 specifically) because that's the capital that absorbs losses while the bank keeps operating. Tier 2 only kicks in once the bank is in resolution. If you have time for one capital number, it's Tier 1.
What to watch for
- Trend. A bank with Tier 1 holding steady at 11% is in a different position than one falling from 13% to 10% over four quarters.
- Asset growth. Rapid loan growth eats into the ratio's denominator faster than retained earnings build it up. Watch for capital ratios sliding during growth phases.
- Buybacks and dividends. A high payout ratio compresses Tier 1 over time. Many community banks deliberately run a Tier 1 ratio they consider "too high" so they can return capital through buybacks.
- Loan mix shifts. Moving from residential mortgages (50% risk weight) to commercial real estate (100% risk weight) raises RWA and compresses the ratio even if total assets are flat.
Related reading
- What is a UBPR? - the report where Tier 1 ratios show up alongside peer percentiles.
- How do FFIEC peer groups work? - capital comparison is much more useful inside a peer group than against industry averages.
- Federal Reserve: large bank capital requirements - official source on the framework.