The Capital of a bank is divided into different tiers according to the characteristics / qualities of each qualifying instrument. The Basel III framework tightens the capital requirements by limiting the type of capital into two categories viz. Tier I and Tier II for supervisory purposes of capital. The Tier II or Tier 2 capital is the secondary component of bank capital, in addition to Tier 1 capital, that makes up a bank’s required reserves.
Infact, Tier II capital is broader measure of tier I capital and it is alienated into lower and upper tiers. The upper tier consists of undated subordinated debt on which the bank can defer the interest payments. Other subordinate debts are classified as lower tier II capital.
Tier II capital consist of following;
i. Undisclosed reserves
ii. General provisions and Loss Reserves
iii. Hybrid debt capital such as Bonds.
iv. Long term unsecured loans.
v. Debt Capital instruments.
vi. Redeemable cumulative Preference Shares.
vii. Perpetual Cumulative preference shares
viii Any other type of instrument generally notified by the Reserve Bank from time to time for inclusion in Tier 2 capital;
(Less: Regulatory adjustments / deductions applied in the calculation of Tier 2 capital)
Tier II items qualify as regulatory capital to the extent that they can be used to absorb losses arising from a bank’s activities.However, Tier II’s capital loss absorption capacity is lower than that of Tier I capital.
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