Tier 1 Capital Ratio

A comparison between a banking firm's core equity capital and total risk-weighted assets. A firm's core equity capital is known as its Tier 1 capital and is the measure of a bank's financial strength based on the sum of its equity capital and disclosed reserves, and sometimes non-redeemable, non-cumulative preferred stock. A firm's risk-weighted assets include all assets that the firm holds that are systematically weighted for credit risk. Central banks typically develop the weighting scale for different asset classes, such as cash and coins, which have zero risk, versus a letter or credit, which carries more risk.

Regulators use the Tier 1 capital ratio to grade a firm's capital adequacy as one of the following rankings: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. A firm must have a Tier 1 capital ratio of 6% or greater, and not pay any dividends or distributions that would affect its capital, to be classified as well-capitalized. Firms that are ranked undercapitalized or below are prohibited from paying any dividends or management fees. In addition, they are required to file a capital restoration plan.