Chapter 2 · Part 2 — Core Capital and Total Capital Fund
Core Capital and Total Capital Fund
What is actually inside Tier 1 and Tier 2, and why the gap between the two columns is the most informative number in the solvency family.
Two rupee columns sit at the left of the KFI table before any percentage appears. They are the foundation of everything that follows, and the gap between them is the most informative number in the solvency family.
Why a bank needs capital at all
A bank is a machine for holding other people's money and lending it out. Look at the shape of the balance sheet:
A NEPALI COMMERCIAL BANK, ROUGHLY, AT SYSTEM SCALE (Chaitra end 2082, Rs million) ASSETS LIABILITIES + EQUITY ┌───────────────────────────┐ ┌───────────────────────────┐ │ │ │ │ │ Loans │ │ Deposits │ │ 5,253,193 │ │ 7,136,173 │ │ │ │ │ │ │ │ ← other people's money │ │ │ │ │ ├───────────────────────────┤ │ │ │ Liquid assets, │ │ │ │ investments, cash, │ ├───────────────────────────┤ │ everything else │ │ Capital 608,991 (core) │ │ │ │ ← the owners' money │ └───────────────────────────┘ └───────────────────────────┘
Core capital across all twenty commercial banks is Rs 608,991 million against Rs 7,136,173 million of deposits. The owners have put in roughly one rupee for every twelve the depositors have.
That is the entire point. Capital is the slice of the balance sheet that belongs to shareholders, and therefore the slice that can be wiped out before a single depositor loses anything. When a loan goes bad, the loss travels in one direction:
WHO ABSORBS A LOSS, AND IN WHAT ORDER
Loss on the loan book
│
▼
┌─────────────────────┐
│ 1. PROFITS │ this year's earnings absorb it first
└─────────┬───────────┘
▼
┌─────────────────────┐
│ 2. CORE CAPITAL │ retained earnings, then paid-up capital
│ (Tier 1) │ ← shareholders lose here
└─────────┬───────────┘
▼
┌─────────────────────┐
│ 3. TIER 2 │ subordinated debenture holders lose here
└─────────┬───────────┘
▼
┌─────────────────────┐
│ 4. DEPOSITORS │ ← the whole regulatory apparatus exists
│ │ to stop the loss reaching this line
└─────────────────────┘Capital adequacy regulation is the rule that says: keep enough in boxes 2 and 3 that the loss never reaches box 4.
Core Capital — Tier 1
The KFI footnote is terse: "Core Capital = Tier I capital."
Tier 1 is the capital that is unambiguously loss-absorbing while the bank is still a going concern. It is permanent, it does not have to be repaid, and it does not oblige the bank to pay anything out.
CORE CAPITAL (TIER 1) — the components, in principle ┌──────────────────────────────────────────────────────────┐ │ ADDED │ │ Paid-up equity share capital │ │ Share premium │ │ Statutory general reserve │ │ Retained earnings / accumulated profit │ │ Capital redemption and other free reserves │ ├──────────────────────────────────────────────────────────┤ │ DEDUCTED [R] │ │ Goodwill and intangible assets │ │ Deferred tax assets │ │ Investment in the equity of licensed institutions │ │ Fictitious assets, unrecovered losses │ │ Other items the directive names │ └──────────────────────────────────────────────────────────┘
The deductions are the part investors forget. Core capital is not "total equity" from the balance sheet. A bank can show healthy equity in its NFRS accounts and materially less core capital in its regulatory return, because regulation refuses to count assets that would evaporate in a stress — goodwill you cannot sell, a deferred tax asset that is only worth something if you make future profits, an equity stake in another bank that would fall at exactly the same time yours does.
Total Capital Fund — Tier 1 plus Tier 2
The footnote again: "Total Capital Fund = Tier I and Tier II Capital."
So:
┌────────────────────────────────────────────────────────┐ │ │ │ TOTAL CAPITAL FUND = CORE CAPITAL + TIER 2 │ │ │ │ and therefore, from the KFI sheet: │ │ │ │ TIER 2 = Total Capital Fund − Core Capital │ │ │ └────────────────────────────────────────────────────────┘
That subtraction is free — both columns are printed — and it is the most useful arithmetic you can do on the solvency block.
Tier 2 is gone-concern capital. It absorbs losses too, but later, and it is not permanent. Typically it contains:
TIER 2 (SUPPLEMENTARY) CAPITAL — in principle [R]
Subordinated term debt / debentures
← borrowed money that ranks below depositors,
usually 5-7 year maturity, amortised in the
final years toward redemption
General loan loss provision
← provisions held against performing loans, i.e.
against losses not yet identified
Exchange equalisation reserve
Investment adjustment reserve
Asset revaluation reserve
Hybrid instrumentsThe critical difference:
| Core capital (Tier 1) | Tier 2 | |
|---|---|---|
| Permanent? | Yes | No — debentures mature |
| Must be repaid? | No | Yes, at maturity |
| Absorbs loss while trading? | Yes | Only in resolution, in practice |
| Can be raised quickly? | Rights issue, slow and dilutive | Debenture issue, faster |
| Costs the bank? | Dividends, discretionary | Coupon, contractual |
The gap, and what it tells you
Do the subtraction across the system:
COMMERCIAL BANKS, CHAITRA END 2082 (Rs million)
Total capital fund 793,490
Core capital −608,991
─────────
Tier 2 184,499 = 23.3% of total capital fund
So roughly ONE RUPEE IN FOUR of the system's regulatory capital
is supplementary capital, not permanent equity.Now the same subtraction bank by bank. This is where it gets interesting.
TIER 2 AS A SHARE OF TOTAL CAPITAL FUND — the extremes Chaitra end 2082, Rs million bank core TCF tier 2 tier2/TCF ───────────────────────────────────────────────────────────────── NIC Asia 15,458 27,307 11,849 43.4% Prabhu Bank 26,080 37,295 11,215 30.1% Kumari Bank 33,495 47,113 13,618 28.9% Nabil Bank 58,006 74,883 16,877 22.5% Global IME 54,607 67,826 13,219 19.5% ───────────────────────────────────────────────────────────────── System 608,991 793,490 184,499 23.3%
NIC Asia has 43.4% of its regulatory capital in Tier 2. Nearly half of the cushion that makes the bank look adequately capitalised is not permanent equity. It is instruments that mature, that must be repaid, and that amortise out of eligibility as they approach maturity.
That is not a rule breach. It is a fact about the quality of the capital, and it is invisible if you only read the CAR percentage — which is exactly why tomorrow's lesson separates CCAR from CAR.
Worked example — reconstructing Tier 2 and testing it
Illustrative arithmetic on published figures. Take NIC Asia at Chaitra end 2082 and ask what happens as its debentures mature.
STEP 1 — Split the capital
Total capital fund Rs 27,307 m
Core capital (Tier 1) Rs 15,458 m
────────────
Tier 2 Rs 11,849 m
STEP 2 — Recover the risk-weighted exposure
The bank sheet does not print RWE. But CCAR is core capital
divided by RWE, so RWE can be recovered:
Core capital 15,458
RWE = ─────────────── = ───────────── = Rs 238,549 m
CCAR 0.0648
Check it against CAR: 27,307 / 238,549 = 11.45% OK
(the sheet prints 11.45% — the arithmetic closes)
STEP 3 — Stress it: what if half the Tier 2 amortises out?
Tier 2 falls 11,849 → 5,925
Total capital fund 15,458 + 5,925 = Rs 21,383 m
New CAR = 21,383 / 238,549 = 8.96%
CCAR is unchanged at 6.48% — core capital did not move.The bank's headline CAR falls from 11.45% to 8.96% without a single loan going bad, without a single rupee of loss, purely because supplementary capital aged. Whether that breaches anything depends on the minimum in force [R] — but the direction, and the fact that it can happen on a calendar rather than in a crisis, is the lesson.
The finance-company sheet adds Paid-up Capital
Class "C" institutions get a column the banks do not: Paid up Capital. Put it next to core capital and a third relationship appears.
PAID-UP vs CORE CAPITAL — Chaitra end 2082 (Rs thousand) company paid-up core core − paid-up ─────────────────────────────────────────────────────────────────── Shree Investment & Finance 1,000,000 1,248,044 +248,044 Guheshwori Merchant 1,012,176 1,115,287 +103,111 ICFC Finance 1,183,471 1,893,214 +709,743 Manjushree Finance 1,351,553 2,252,384 +900,831 ─────────────────────────────────────────────────────────────────── Progressive Finance 848,106 468,516 −379,590 Samriddhi Finance 818,911 299,937 −518,974 Pokhara Finance 1,082,557 (34,627) −1,117,184 Janaki Finance 690,473 (300,192) −990,665
Read the sign.
Core capital above paid-up means the institution has accumulated reserves and retained earnings on top of what shareholders subscribed. It has been profitable and has kept some of it. Manjushree has built Rs 900 million of capital beyond the shares it issued.
Core capital below paid-up means accumulated losses have eaten into subscribed capital. Samriddhi's shareholders put in Rs 819 million; Rs 299 million of regulatory core capital remains. Roughly Rs 519 million has been consumed.
Core capital negative means the losses have consumed the entire subscribed capital and kept going. Janaki Finance's shareholders subscribed Rs 690 million; core capital is negative Rs 300 million.
┌──────────────────────────────────────────────────────────────┐ │ JANAKI FINANCE COMPANY LIMITED — Chaitra end 2082 │ │ │ │ Paid-up capital +690,473 thousand │ │ Core capital −300,192 thousand │ │ ────────── │ │ Destroyed ~990,665 thousand │ │ │ │ That is 143% of everything shareholders ever put in. │ │ The equity is gone, and the hole continues past zero │ │ into money that belongs to someone else. │ └──────────────────────────────────────────────────────────────┘
We will finish this institution on Day 3, when the negative CCAR makes the consequence explicit, and again on Day 5, when its 59.12% NPL explains how it got there.
The trap: capital is not cash
A bank with Rs 31,548 million of core capital does not have Rs 31,548 million sitting anywhere. Capital is a liability-side concept — it describes who has a claim on the assets, not what the assets are.
WRONG MENTAL MODEL RIGHT MENTAL MODEL "The bank has capital, "The bank's assets exceed its like a reserve fund it non-equity liabilities by this can spend" much. That is all." ┌────────────┐ ASSETS LIABILITIES │ vault │ ┌──────┐ ┌──────────┐ │ ┌──────┐ │ │ │ │ deposits │ │ │capital│ │ │ │ ├──────────┤ │ └──────┘ │ │ │ │ capital │ ← a claim, └────────────┘ └──────┘ └──────────┘ not a thing
This is why a bank can be adequately capitalised and still fail tomorrow — capital says nothing about whether it can pay a depositor on Sunday morning. That is liquidity, and it is Day 4.
Formulas from today
Tier 2 = Total Capital Fund − Core Capital
Tier 2 share = (Total Capital Fund − Core Capital)
───────────────────────────────────
Total Capital Fund
Implied RWE = Core Capital ÷ CCAR
(bank sheet only — (cross-check: Total Capital Fund ÷ RWE
RWE is not printed) should equal the printed CAR)
Accumulated result = Core Capital − Paid-up Capital
(finance sheet only) positive = reserves built
negative = capital consumedWhat you should be able to do now
- Explain in one sentence why capital exists, and who it protects.
- List what goes into Tier 1 and what is deducted, and say why the deductions exist.
- Compute Tier 2 from the two printed columns and interpret its share.
- Recover risk-weighted exposure from the bank sheet and check your answer against the printed CAR.
- Read paid-up versus core capital on the finance sheet and say whether the institution has built or destroyed shareholder capital.
- Explain why capital is not cash.
Tomorrow: CCAR and CAR — the two percentages everyone quotes, why the gap between them is the point, and what a negative capital ratio actually means.
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