What Are Undisclosed Reserves?
Let me explain undisclosed reserves to you directly: these are the unpublished or 'hidden' reserves that don't show up on public documents like the balance sheet, but they're real assets, and most banking institutions treat them that way.
You need to know that bank reserves are the cash minimums financial institutions must keep on hand. The Federal Reserve sets these requirements to make sure banks can cover withdrawals.
Key Takeaways
Here's what you should remember: undisclosed reserves are on a financial institution's books but hidden from the public and not listed on financial statements. They're included as part of Tier 2 capital along with general loan-loss and revaluation reserves. Keep in mind that some countries' regulatory environments do not recognize undisclosed reserves as assets.
Understanding Undisclosed Reserves
Undisclosed reserves tie into capital requirements in banking and are designated as Tier 2 capital. Tier 2 is the second or supplementary layer of a bank's capital, and it's less liquid than Tier 1 capital.
These reserves get included in Tier 2 capital and happen through provisions or when a bank charges expenses against its profit and loss. They're not disclosed and not visible on public statements like the balance sheet. Tier 2 capital, or supplementary capital, includes several important components of a bank's capital requirement.
Typical Items in Tier 2 Capital Calculations
- Undisclosed reserves
- Revaluation reserves
- General loan-loss reserves
- Hybrid debt-equity capital instruments
- Subordinated term debt
More on Tier 1 and Regulations
Tier 1 capital, also known as core capital, is more liquid and consists of equity capital and disclosed reserves, like retained earnings. It's the money the bank has on its books for lending, investing, trading, or other risky transactions. In simple terms, Tier 1 funds help banks absorb losses without shutting down operations.
Tier 1 and Tier 2 capital requirements were largely standardized in the Basel I accord from the Basel Committee on Banking Supervision, and Basel II left them untouched. Most countries' national regulators have implemented Tier 2 standards in local laws. In regulatory capital calculations, Tier 2 is limited to 100% of Tier 1 capital.
Undisclosed Reserves Special Considerations
Preferred forms of capital and collateral have become more important, especially after the 2008-2009 banking crisis. Bank stress tests, done in response to taxpayer-funded bailouts, showed how certain assets and reserves were inadequate during the Great Recession's volatile markets.
In practice, undisclosed reserves aren't common, but some regulators accept them when a bank makes a profit that doesn't appear in normal retained earnings or general reserves. It's fairly standard for a bank's supervisory authorities to accept undisclosed reserves. However, many countries don't accept them as an accounting concept or a legitimate form of capital.
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