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Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It consists of the types of financial capital considered the most reliable and liquid, primarily equity. Examples of Tier 1 capital are common stock, preferred stock that is irredeemable and non-cumulative, and retained earnings.
The theoretical reason for holding capital is that it should provide protection against unexpected losses. Note that this is not the same as expected losses -- provisions and reserves are for expected losses.
Tier 2 capital is a measure of a bank's financial strength with regard to the second most reliable forms of financial capital, from a regulator's point of view. It consists of accumulated after-tax surplus of retained earnings, revaluation reserves of fixed assets and long-term holdings of equity securities, general loan-loss reserves, hybrid (debt/equity) capital instruments, and subordinated debt.
Tier 1 capital is the most reliable form of capital.
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