Under the Basel I framework, Tier 1 Capital, also known as core capital, includes common equity and disclosed reserves minus goodwill. Common equity is the most fundamental form of capital and represents the ownership interest in a bank. It includes ordinary shares and retained earnings. This type of capital is considered the highest quality because it is fully available to cover losses. Therefore, common equity is not a part of Tier 2 capital, which is supplementary capital and includes other forms of capital that are less secure and reliable than Tier 1 capital.

Choice A is incorrect. Undisclosed reserves are indeed a part of Tier 2 capital under the Basel I framework. These reserves are created or increased through appropriations of retained earnings or other surplus, such as share premiums, general reserves, and legal reserves.

Choice C is incorrect. Hybrid instruments are also included in Tier 2 capital under Basel I framework. These instruments combine characteristics of both debt and equity and provide a supplementary source of capital for banks.

Choice D is incorrect. Loan loss reserves not allocated to non-performing assets form part of Tier 2 Capital as per Basel I norms. They serve as buffers against potential losses from loans that may default in future.

Things to Remember

• Basel I framework was the first international framework for banking regulations developed by the Basel Committee on Banking Supervision.
• Tier 1 Capital is considered the highest quality capital as it is fully available to cover losses and includes common equity and disclosed reserves minus goodwill.
• Tier 2 Capital is supplementary capital that includes undisclosed reserves, hybrid instruments, and certain types of loan loss reserves.
• Common equity represents the ownership interest in a bank and is not a part of Tier 2 capital.
• Undisclosed reserves are created or increased through appropriations of retained earnings or other surplus and are part of Tier 2 capital.
• Hybrid instruments combine characteristics of debt and equity and provide additional