Tier 2 Capital

Tier 2 capital is supplementary bank capital that provides additional loss absorption capacity beyond Tier 1, though it’s less permanent and subordinated to depositors and senior creditors. Components include subordinated debt with original maturity exceeding five years, hybrid instruments, loan loss reserves (up to 1.25% of risk-weighted assets), and revaluation reserves. Under Basel III, total capital (Tier 1 + Tier 2) must equal at least 8% of risk-weighted assets. For example, after meeting 6% Tier 1 requirement, a bank needs 2% additional Tier 2 capital. Tier 2 subordinated debt must have minimum five-year maturity with no incentives for early redemption. It’s amortized during final five years, reducing qualifying amount by 20% annually. During resolution, Tier 2 capital absorbs losses after equity but before senior debt and deposits. While cheaper than equity, Tier 2 is more expensive than senior debt due to subordination. Banks optimize capital structure balancing cost with regulatory requirements. Tier 2 instruments may include write-down or conversion features triggered by regulatory events or capital ratios breaching thresholds.