Describe liquidity using Tier 1 and total-risk capital ratio calculations. Solution Tier 1 Capital is the equity capital of the bank It would roughly include common stock, prefered stock and reserves Risk weight assets is capital required to be set aside by banks . The risk weight is a function of the risk perception tof fed has on different portfolio of loans like for unsecured loans risk woeight would be say 1.25 Now we have calculated tier 1 capital and risk weighted assets .Now so that bank has cushion of capital when its loans default Fed would develop a ratio to be maintained called capital adequcy ratio which is nothing but tier 1 capital/riskweighted assets which is some hwere beteween 8% to 10% Banks have to maintain this ratio so that they have some capital in case loans have default.