The own funds of an institution consist of the sum of its tier1 capital and tier2 capital. Tier1 capital comprises common equity tier1 capital and additional tier1 capital.
The Capital Requirements Regulation (CRR) stipulates, inter alia, what can be recognised as capital in prudential terms. It also contains regulations for reducing own funds as well as items which are to be deducted from capital.
Common equity tier1 capital (Articles26-50 CRR )
Supervisors focus particularly on institutions’ common equity tier1 capital (CET1). It consists of paid-in capital instruments which have to fulfil certain requirements, and disclosed reserves. Both components must be available to institutions for unrestricted and immediate use to cover risks or losses. Institutions must have a common equity tier1 capital ratio of at least 4.5%. Capital buffer requirements also have to be met using CET1 capital.
Additional tier1 capital (Articles51-61 CRR)
Like common equity tier1 capital, additional tier1 capital (AT1) should be continuously available for loss absorbency purposes, thereby enabling the bank to continue on a going-concern basis. Some of the key requirements that instruments in this capital class must meet are that they be subordinated, that they be perpetual, and that distributions be fully discretionary. Moreover, for additional tier1 capital, institutions must ensure that it is possible for the instruments to be converted into common equity tier1 capital or to be written down, at the latest once the common equity tier1 capital ratio falls below a threshold of 5.125%. The sum of common equity tier1 capital and additional tier1 capital is called tier1 capital. Institutions must have a tier1 capital ratio of at least 6.0%.
Tier2 capital (Articles62-71 CRR)
The function of tier2 capital is to provide creditor protection in the event of insolvency. Tier2 capital instruments must have an original maturity of at least five years and must be subordinated with respect to repayment if the institution becomes insolvent. The sum of common equity tier1 capital, additional tier1 capital and tier2 capital is called total capital. Institutions must have a total capital ratio of at least 8.0%.
