What Does Tier II Mean?


One hears the terms "Tier I" and "Tier II" in various contexts in modern American society, ranging from tiered compensation for salesmen to levels of intervention for children with academic difficulties. However, probably the most common usage of Tier 1 and Tier 2 in recent years relates to the description of the type of capital reserves that banks are required to maintain.

Bank Capital Reserve Requirements

Bank capital reserve requirements had been reduced several times in the decade or so preceding the financial crisis of 2008, and many economists have pointed to lower reserves as being one of the major contributing factors behind the failures of many banks and other financial institutions. The financial reform legislation passed by the U.S. Congress in 2009 and 2010 tightened up capital reserve requirements for banks — specifically, the ratio of Tier 1 to Tier 2 reserves.

Tier 1 Capital

Tier 1 capital reserves are liquid or near-liquid reserves that can be used to meet immediate financial needs. Tier 1 capital generally includes retained corporate earnings, and any holdings of common stock or preferred stock.

Tier 2 capital

Tier 2 capital reserves are less liquid; they might take some time to liquidate and use to meet financial needs. Tier 2 capital is broader category, and generally includes revaluation reserves, subordinated debts (other debtors have first claim if the debtor defaults) and other general provisions (debts of currently unknown status).

Core Capital

The term core capital is generally synonymous with Tier 1 capital; it is typically used to refer to the capital reserve requirements for thrifts, or savings and loan institutions.

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