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FRM Part II · FRM Exam Part II · Capital Structure in Banks

A bank's risk manager is reviewing the composition of regulatory capital under Basel III. Which of the following instruments is classified as Common Equity Tier 1 (CET1) capital?

Retained earnings and common shares are CET1 capital, the highest quality of regulatory capital. Perpetual non-cumulative preferred shares are Additional Tier 1, whereas subordinated term debt and eligible general provisions are Tier 2 instruments that absorb losses only in gone-concern situations.

  1. APerpetual non-cumulative preferred shares with a discretionary coupon
  2. BSubordinated debt with an original maturity of ten years
  3. CRetained earnings and common shares issued by the bankCorrect
  4. DGeneral loan loss provisions up to a regulatory cap

Explanation

CET1 consists mainly of common shares and retained earnings (plus related surplus and other disclosed reserves). Perpetual non-cumulative preferred shares are Additional Tier 1, while subordinated debt and eligible general provisions are Tier 2.

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