Tier 2 Capital
Tier 2 Capital
Tier 2 capital refers to any capital that is subordinate to tier 1 capital. Tier 1 capital consists of common equity shares and preferred stock that are not subordinate to any other security. Tier 2 capital includes various instruments, such as subordinated debt, convertible debt, and hybrid securities.
Characteristics of Tier 2 Capital:
- Subordinated to Tier 1 Capital: Tier 2 capital is subordinate to tier 1 capital in the capital hierarchy. It is not used to meet the firm’s required minimum capital ratio, but is used to supplement tier 1 capital in times of need.
- Lower Priority: Holders of tier 2 capital have a lower priority in the event of bankruptcy than holders of tier 1 capital. They are only entitled to receive payments if there are any funds remaining after satisfying the claims of tier 1 creditors.
- Typically Lower Returns: Tier 2 capital typically offers lower returns than tier 1 capital. This is because investors know that they are at a higher risk of losing their investment in the event of bankruptcy.
- High Liquidity: Tier 2 capital can be more liquid than other types of subordinated debt, such as mezzanine debt. This is because there is a greater market for tier 2 capital than for other subordinated debt.
- Collateralized or Uncollateralized: Some tier 2 capital instruments, such as subordinated debt, are collateralized by specific assets, while others are not. Uncollateralized tier 2 capital is known as high-yield debt.
Examples of Tier 2 Capital Instruments:
- Subordinated debt
- Convertible debt
- Hybrid securities
- Asset-backed securities
- Emerging markets debt
Uses of Tier 2 Capital:
- To supplement tier 1 capital in times of need
- To meet regulatory requirements for minimum capital ratios
- To provide additional liquidity to the firm
- To generate additional returns for investors
Note: The specific definition and composition of tier 2 capital may vary depending on the industry and jurisdiction.