Equity Capital - An overview

Equity capital represents the ownership in a company and its residual claim to the company's assets and earnings.

Summary: Equity capital is money that investors pour into the company. It could also be the retained earnings from a company's net profits. This capital is used to fund the company's activities, including investments and operations. It can be categorised in various ways, including regulatory (Tier 1 and Tier 2 per the previous post), internal vs external (retained earnings vs injections), and form (ordinary vs preferred).

Continuing from the earlier post on Tier 1 and Tier 2 capital, I will explain more about this classification of capital below. 

The tiering of this capital is dependent on its quality and ability to absorb losses.

Tier 1: Core Capital

1) Common Equity Tier 1 ("CET1"): Highest quality and best able to absorb losses.  It is considered "going concern" capital, which means it absorbs losses while the bank continues its operations. Examples of such capital include ordinary shares, retained earnings and accumulated other comprehensive income.

2) Additional Tier 1 ("AT1"): Next highest quality and able to provide significant loss-absorbing capacity. This type of capital is typically perpetual, have discretionary and non-cumulative dividend payments, and have loss absorption triggers.

Tier 2: Supplementary Capital

1) Considered to be supplementary capital, lower quality than Tier 1 because it is not as permanent and has lower capacity for absorbing losses. Designed to absorb such losses after Tier 1 capital has been depleted. Examples of such capital include subordinated term loans, hybrid capital instruments (quasi-equity), and loss provisions.

To note, these types of capital are not reported as such on the balance sheet. While the balance sheet shows individual line items, CET1, AT1 and Tier 2 capital represent various line items adjusted for rules according to regulatory requirements.