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Tier one capital ratio

A tier one capital ratio is a measure of financial health of bank.

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Expanded Definition

Tier one capital is a bank's core capital and includes only equity capital and disclosed reserves. The ratio is calculated by dividing Tier one capital by a bank's total risk-weighted assets. Banks are required by law to maintain a tier one capital ratio above 4% in the United States, Anything above 13% is considered very conservative. As of October, 2008 the median tier one capital ratio for banks is about 10.5%.

Use to Investors

In this modern day and age of accounting, investors are are best served to be suspicious of any results banks post. In the past a high tier capital ratio was to be taken as a sign of conservative but sound banking. However in practice most banks only carry high ratios when they have gotten in financial trouble. Banks will boast that they have a high tier one capital ration in an attempt to calm fears. In the modern age where level 3 assets and many hidden off balance sheet assets, tier one capital's importance to the actual health of the bank and its ability to sustain losses is debatable. Some investors instead now consider banks raising tier one capital ratio to be a bearish sign of a bank's future prospects. A low tier one capital ratio should be considered a sign that a bank may cut its dividend, if it has one.

2008 Bailout Implications

The 9 banks that received equity injections from the Treasury under the TARP as a consequence saw their tier one capital ratios rise enormously (some in excess of 15%). The government's hope is that this will encourage the banks to lend once more, unfreezing the credit market. This is ongoing as of this writing.

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