Tier 1 Capital, market value of common stock or shareholders equity?

October 11, 2016 3:27 PM

I am trying to understand the definition of Tier 1 capital. Internet sources seem contradictory. I understand the concept but I am confused as to whether it is shareholder equity or the market value of all shares of common stock that make up the portion that is not retained earnings, preferred stock or creative things. Wikipedia does not make this clear. Also if you can point me at a good resource for answering these kind of simple but slightly obscure questions I would appreciate it.

A further question would be: why would the market value of common stock be considered to be the banks capital? As a proxy for the ability to raise more cash?

posted by Pembquist to Law & Government (8 answers total)

Best answer: As a matter of process, have you looked at any bank 10ks? That should give some information.

Eg, here's PNC's 10K, and it lists out the elements of regulatory capital on p. 48.
posted by jpe at 3:37 PM on October 11, 2016

So, from the PNC calcs, you can see the common equity isn't market cap but just the residual equity value / shareholder equity.

Edgar is the bomb.
posted by jpe at 3:46 PM on October 11, 2016

If you think about the purpose of the regulatory tiering of capital it should be instantly obvious that assets held by completely unrelated third parties on which the regulated entity has no claim simply can't be any tier.
posted by praemunire at 5:21 PM on October 11, 2016

Best answer: Tier one capital is essentially tangible common equity + adjustments that may or may not be obvious from the gaap financial statements. Things like deferred tax assets etc.
posted by JPD at 5:33 PM on October 11, 2016

Also you arguably have the logic reversed btw. The value of the company is a function of capital, not the other way around.

The BIS is a good source for this stuff.
posted by JPD at 5:35 PM on October 11, 2016

Response by poster: Thanks for the replies, very helpful. The 10K link was especially helpful. praemunire is spot on about what is obvious (hence my confusion and frustration,) JPD gives a lucid answer which is pretty much what made sense to me. The source of my confusion was a misunderstanding of the phrases "common stock" and "common stock value" and the misunderstanding of the same by internet "experts" who thought it meant stock price, which is nonsense in this context. The abbreviated answer would be "its common stock as on a balance sheet dummy."

JPD if you read this can you tell me what I said that is backwards? I think you mean the logic in idea that change in stock price equals change in capital, but I'm not sure.
posted by Pembquist at 10:45 PM on October 11, 2016

Yes - the causal relationship is mostly capital influences market value. Basically because the earnings power of a bank is mostly a function of how much capital it has. I mean that's eliding a lot things but in one sentence that's good enough. Banking is basically a cost of capital business (with a spread for a funding advantage)so market value =book value. Again mass over simplification.

Also I think focusing too much on CET1 is a bit of a mistake. CET1 is a basel ratio that is usually compared to Risk-Weighted Assets (RWA) to get a Tier1 Capital Ratio. The problem is that the risk weightings on the assets is a bit opaque. That might change with Basel 4, but who really knows for now. Also during a crisis people disbelieve the risk-weightings. I.e. in 2012 no one actually believed the risk weightings for Sovereign Debt, so you couldn;t really know if the european banks were adequately capitalized on a CET1/RWA basis. Also if you look at CET1/RWA you also have to think about the leverage.

If the US crisis if you just ignored all of the Basel Stuff and in the fall of 2008 said I'm going to buy the banks that were not funded by the capital markets (i.e. deposit funded) and those with the best ratio of tangible equity to tangible assets you did really really well for yourself.
posted by JPD at 5:25 AM on October 12, 2016

Response by poster: Well put JPD. I don't have any experience or education in finance so what happens to me is that while I think I know what is going on, (your first paragraph is what I would have said if I could articulate my understanding,) I often feel undermined by a lack of terminology and system detail. For instance I scratch my head over the term RWA because while risk modeling sounds very empirical and mathy my intuition tells me that the primary force effecting its accuracy might not always be truth seeking. My gut tells me that creating a risk model itself creates another category of risk, however, since I lack a basic understanding of how one goes about creating a risk model or even much beyond the most basic understanding of statistics, I feel like I might be wrong and I cannot figure out who to ask. Your use of the word "opaque" in this regard makes me feel better.
posted by Pembquist at 10:37 AM on October 12, 2016