Table of Contents
- What Is the Tier 1 Leverage Ratio?
- Key Takeaways
- Tier 1 Leverage Ratio Formula
- How to Calculate the Tier 1 Leverage Ratio
- What Does the Tier 1 Leverage Ratio Tell You?
- Tier 1 Leverage Ratio Requirements
- Real-World Example of the Tier 1 Leverage Ratio
- The Difference Between the Tier 1 Leverage Ratio and the Tier 1 Capital Ratio
- Limitations of Using the Tier 1 Leverage Ratio
- FAQs
- The Bottom Line
What Is the Tier 1 Leverage Ratio?
Let me explain the Tier 1 leverage ratio directly: it measures a bank's core capital relative to its total assets. You look specifically at Tier 1 capital to see how leveraged the bank is based on those assets. Tier 1 capital includes assets that can be quickly liquidated if the bank faces a crisis. This ratio gives you a clear view of the bank's near-term financial health.
Regulators use this ratio to ensure banks maintain adequate capital and limit how much they leverage their capital base. That's the essence of it.
Key Takeaways
The ratio compares Tier 1 capital to total assets to evaluate leverage. Bank regulators apply it to confirm banks have enough liquidity for stress tests. A ratio over 5% signals strong financial standing for the bank.
Tier 1 Leverage Ratio Formula
Here's the formula you need: Tier 1 Leverage Ratio = (Tier 1 Capital / Consolidated Assets) × 100. Tier 1 Capital includes common equity, retained earnings, reserves, and certain other instruments.
How to Calculate the Tier 1 Leverage Ratio
To calculate it, put the bank's Tier 1 capital in the numerator. This covers common equity, retained earnings, reserves, and instruments with discretionary dividends and no maturity. The denominator is the bank's total consolidated assets, as reported in quarterly or annual earnings.
Divide Tier 1 capital by total assets, then multiply by 100 to get the percentage. That's how you arrive at the ratio.
What Does the Tier 1 Leverage Ratio Tell You?
This ratio, from the Basel III accords proposed in 2009, uses Tier 1 capital to assess a bank's leverage against its assets. A higher ratio means the bank is better positioned to handle balance sheet shocks.
Tier 1 capital is the bank's most stable and liquid assets, effective for absorbing losses in crises. Total exposures in the denominator include consolidated assets, derivatives, and off-balance-sheet items like loan commitments and letters of credit.
Tier 1 Leverage Ratio Requirements
Basel III sets a 3% minimum, with potential increases for systemically important institutions. Since 2018, U.S. rules require bank holding companies with over $700 billion in assets or $10 trillion under management to maintain a 5% ratio with an additional 2% buffer.
If a depository institution is under corrective action for capital deficiencies, it needs at least 6% to be well-capitalized.
Real-World Example of the Tier 1 Leverage Ratio
Take Bank of America from its Q3 2018 report: it reported a Tier 1 leverage ratio of 8.3%. You calculate this by dividing $186.189 billion in Tier 1 capital by $2.240 trillion in total assets, then multiplying by 100. This 8.3% exceeds the 5% regulatory requirement.
The Difference Between the Tier 1 Leverage Ratio and the Tier 1 Capital Ratio
The Tier 1 capital ratio measures core capital against risk-weighted assets, a key Basel III metric for financial strength. In contrast, the leverage ratio uses core capital against total assets without risk weighting, focusing on overall leverage rather than risk-adjusted assets.
Limitations of Using the Tier 1 Leverage Ratio
One limitation is that you rely on banks to accurately report Tier 1 capital and assets. Inaccurate figures skew the ratio. While regulators target above 5%, its true effectiveness shows only in a crisis.
FAQs
What is the Tier 1 leverage ratio of major banks? Above 5% indicates strong health; for Q1 2023, Citibank had 8.82%, JPMorgan Chase 8.60%, Wells Fargo 8.55%, and Bank of America 7.88%.
What is the minimum Tier 1 capital ratio for a bank? Banks need an 8% total capital ratio, with 6% Tier 1, including at least 4.5% Common Equity Tier 1.
What is the difference between CET1 and Tier 1 leverage ratio? CET1 is mainly cash and stock within Tier 1 capital; the leverage ratio divides Tier 1 (CET1 plus additional Tier 1) by total assets.
The Bottom Line
The Tier 1 leverage ratio relates a bank's core capital to its total assets, calculated by dividing Tier 1 capital by average consolidated assets. It measures financial strength, with regulators seeking over 5% for adequate capitalization and liquidity.
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