What Was Tier 3 Capital?

Tier 3 capital con𝓰sisted of low-quality, unsecured debt issued by banks before the Great Financial Crisis. Many banks held tier 3 capital to cover their market, commodities, and foreign currency risks derived from trading activities. What this really means is that banks used loans from other banks t🎉o cover any losses they took while trading on several markets.

If the markets collapsed (which they did), the banks would have to cover losses with higher-quality debt such as shareholder's equity, retained capital, or supplementary capital, draining their accounts.

Under the Basel III Accords, tier 3 capital was required to be phased out starting Jan. 1, 2013, and removed from accounts by Jan. 1, 2022.

Understanding Tier 3 Capital

Tier 3 capital debt used to include a greater number of subordinated issues when compared with tier 2 capital. Subordinat𒁃ed debt falls under other debt in payout priority if the borrower defaults. Subordinated debt is gener💃ally unsecured, meaning there is no collateral for the debt, so the issuer is left to trust that the borrower will pay them back.

Defined by the Basel II Accords, to qualify as tier 3 capital, assets must have been limited to 2.5x a bank's tier 1 capital, have been unsecured, 澳洲幸运5官方开奖结果体彩网:subordinated, and have an original maturity of no ♊less tha👍n two years.

Tier 3 Capital and the Basel Accords

Capital tiers for large financial institutions originated with the 澳洲幸运5官方开奖结果体彩网:Basel Accords. These are three (Basel I, Basel II, and Basel III) agreements, which the 澳洲幸运5官方开奖结果体彩网:Base🅘l Committee on Banki🦂ng Supervision (BCBS) began to roll out in 1988. In gꦅeneral,🎐 all of the Basel Accords provide recommendations on banking regulations concerning capital, market, and operational risks.

The goal of the accords is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses. While ♕violations of the Basel Accords bring no legal ramifications, membꩵers are responsible for implementing the accords in their home countries.

Basel 1

Basel I required international banks to maintain a minimum amount (8%) of capital based on a percent of risk-weighted assets. Basel I also classified a bank's assets into five risk categories (0%, 10%, 20%, 50%, and 100%) based on the nature of the debtor (e.g., government debt, development bank debt, private-sector debt, ꦑand more).

Basel 2

In addition to minimum 澳洲幸运5官方开奖结果体彩网:capital requirements, Basel II focused on regulatory supervision and market discipline. Basel II highlighted the division o꧅f eligible regulatory capital of ꦕa bank into three tiers.

Basel 3

BCBS published Basel III in 2009, following the 澳洲幸运5官方开奖结果体彩网:2008 financial crisis. Basel III was designed to improve the banking sector's ability to deal with financial stress, improve risk management, and strengthen a bank's transparency. Basel III implementation began on Jan. 1, 2013, with a 10 percentage point reduction in Tier 3 assets every year following.

Types of Tier Capital

Tier 1 capital is a bank's 澳洲幸运5官方开奖结果体彩网:core capital, which consists of shareholders' equity and retained earnings; it is of the highest quality and can be liquidated quickly.

Tier 1 capital is intended to measure a bank's financial health; a bank uses tier 1 capital to absorb losses without ceasing business operations.

Tier 2 capital is supplementary capital, i.e., less reliable than tier 1 capital. A bank's total capital is calculated as a sum of its tier 1 and tier 2 capital. Regulators use the 澳洲幸运5官方开奖结果体彩网:capital ratio to determine and rank a bank's 澳洲幸运5官方开奖结果体彩网:capital adequacy.

Tier 2 capital includes 澳洲幸运5官方开奖结果体彩网:revaluation reserves, hybrid capital instruments, and subor🌜dinated debt. In addition, tier 2 capital incorporates gene💮ral loan-loss reserves and undisclosed reserves.

Tier 3 capital consisted of subordinated debt to cover market risk from trading activities, but it is now not used in the banks of Basel A💛ccord member countries.

The Bottom Line

Tier 3 capital used to be common in banking as a way to reduce the risks associated with trading, but it was phased out in 2013 by Basel Accord member countries. This type of capital was associated with contributing to the Great Financial Crisis because it was debt used to cover losses from investments and trading. When large investment and other banks began to fail during the Great Financial Crisis, they didn't have the capital to cover the losses because their backup plan was to use the debt as an emergency fund.