How it works

Own funds is the regulatory term for a bank's capital, the highest-quality resources it holds to absorb losses on a going-concern and gone-concern basis. Own funds are composed of three layers of decreasing quality: Common Equity Tier 1, Additional Tier 1 and Tier 2. Common Equity Tier 1 and Additional Tier 1 together form Tier 1 capital, which absorbs losses while the bank continues to operate; Tier 2 is gone-concern capital that absorbs losses once the bank fails or reaches the point of non-viability.

Each layer must meet detailed eligibility criteria concerning permanence, flexibility of payments and subordination. Common Equity Tier 1 consists mainly of paid-up ordinary shares and retained earnings and ranks last in the creditor hierarchy. Additional Tier 1 instruments are perpetual and carry features such as coupon cancellation and write-down or conversion triggers. Tier 2 instruments are dated subordinated debt with a minimum original maturity. Regulatory deductions and prudential filters are applied to arrive at the final figure for each tier.

Own funds are measured against the total risk exposure amount to produce capital ratios, and they also form the highest-quality component of a bank's MREL, sitting above eligible liabilities in loss-absorbing capacity.

The composition and eligibility of own funds are governed by the Capital Requirements Regulation. Articles 25 to 88 of the CRR set out the full own funds regime, with Common Equity Tier 1 in Articles 26 to 50, Additional Tier 1 in Articles 51 to 61 and Tier 2 in Articles 62 to 71, together with the applicable deductions and transitional provisions. Total own funds requirements are expressed relative to the total risk exposure amount defined in Article 92(3) of the CRR.

In resolution, own funds instruments are the first to absorb losses through the write-down and conversion of capital instruments and the bail-in tool, ranking ahead of eligible liabilities in the sequence of loss absorption.

Practical relevance

For banks, own funds are the foundation of the prudential framework: capital ratios, the combined buffer requirement and the maximum distributable amount are all expressed in terms of own funds, and the quality mix across the three tiers affects both cost and resilience.

For investors, the tiering of own funds maps directly to the risk of each instrument. Holders of Common Equity Tier 1 bear the first loss; Additional Tier 1 holders face coupon cancellation and write-down or conversion on a going-concern basis; Tier 2 holders are exposed on a gone-concern basis. Because own funds also count as the top layer of MREL, the same instruments are integral to resolution planning, linking the prudential and resolution frameworks.