Capital Ratios Definition & Meaning | Financial Term | CSIMarket
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Glossary

Capital Ratios

Financial Term

1. Tier 1 Capital Ratio: This measures a bank*s core capital (common stock and retained earnings) as a percentage of its risk-weighted assets. Tier 1 capital is considered the most reliable and stable source of funding for a bank, so a higher tier 1 capital ratio indicates that the bank has a stronger financial position.

2. Tier 2 Capital Ratio: This measures a bank*s secondary capital (such as subordinated debt and preferred stock) as a percentage of its risk-weighted assets. Tier 2 capital is less reliable than tier 1 capital, so a higher tier 2 capital ratio may indicate a slightly weaker financial position than a higher tier 1 capital ratio.

3. Total Capital Ratio: This measures a bank*s total capital (the sum of tier 1 and tier 2 capital) as a percentage of its risk-weighted assets. The total capital ratio provides a more comprehensive picture of a bank*s financial strength than the tier 1 or tier 2 capital ratios alone.

4. Leverage Ratio: This measures a bank*s tier 1 capital as a percentage of its total assets, regardless of risk. The leverage ratio is a simpler measure of a bank*s financial strength than the other ratios, but it is also less precise since it does not take into account the risk associated with each asset.

Capital ratios are used by regulators to ensure that banks have enough cushion to absorb potential losses and continue operating even during a financial crisis. Banks with higher capital ratios are generally considered safer and more stable, and may be able to attract more investors and customers as a result. However, having too much capital can also be problematic, as it may be a sign that the bank is not investing in profitable ventures or returning value to shareholders.


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