Tier 2 Capital
Supplementary bank capital—including subordinated debt and loan loss reserves—that acts as a secondary loss-absorbing buffer below Tier 1.
What is Tier 2 Capital?
Tier 2 capital is the supplementary capital layer in the Basel III framework that provides a secondary loss-absorbing buffer below Tier 1 capital. It includes instruments and reserves that can absorb losses in liquidation but may not provide the same going-concern protection as Tier 1: subordinated debt with original maturity of at least five years, hybrid capital instruments, and general loan loss reserves (allowances for credit losses up to 1.25% of risk-weighted assets). Tier 2 capital can absorb losses when a bank fails or is wound down ('gone-concern' capital). Under Basel III, Total Capital (Tier 1 + Tier 2) must equal at least 8% of risk-weighted assets, plus the 2.5% conservation buffer.
Example
A bank issues $1 billion of 10-year subordinated notes (qualifying as Tier 2 capital) to build its Total Capital ratio above regulatory minimums without diluting shareholders with new common equity. The subordinated notes rank below senior creditors and deposits in case of insolvency, but above common equity—meaning holders bear losses before depositors. Basel III phases out the capital credit for Tier 2 instruments in the five years before maturity.