Tier 2 capital

Tier 2 capital is used to calculate the tier 2 capital adequacy ratio, a broader measure than the tier 1 ratio. Tier 2 capital is tier 1 capital plus subordinated debt and some less certain assets such as revaluation reserves.

The tier 2 ratio is much the same as the tier 1 ratio: tier 2 capital ÷ risk weighted assets.

Tier 2 capital is divided into lower and upper tiers. The upper tier consists of undated subordinated debt on which the bank can defer interest payments, essentially identical to cumulative prefs which would also fall into this tier. The upper tear also includes revaluation reserves. General provisions would also fall into this category, but as IFRS only allow specific provisions this is no longer relevant.

Other subordinated debt is classified as lower tier 2 capital

The tier 2 capital ratio is the most relevant measure for depositors, counter-parties and other holders of banks' debt other than the subordinated debt. It tells us what proportion of the banks assets could be lost with the loss entirely absorbed by holders of equity, hybrid and subordinated debt.