5.1 The Equity Technique, Different Perspectives 137base must consist of Tier 1 capital as defined in the Basel II Accord. Elements of
supplementary capital will be admitted into Tier 2 limited to 100% of Tier 1.^14
Tier 1 capital means equity capital and disclosed reserves. Equity capital means
“issued and fully paid ordinary shares/common stock and non-cumulative perpet-
ual preferred stock (but excluding cumulative preferred stock)”.^15
Tier 2 capital or supplementary consists of undisclosed reserves,^16 revaluation
reserves,^17 general provisions/general loan-loss reserves,^18 hybrid debt capital in-
struments,^19 and certain subordinated term debt.^20
The many aspects of “equity” can be illustrated by the effect of the financial crisis on the
minimum capital requirements of banks. In principle, one could use three balance-sheet re-
lated ways to rescue banks after the collapse of the market valuation of their assets. Banks
could be permitted to use other than market values for accounting purposes (IFRS). Alter-
natively, the minimum capital requirements (Basel II and the Capital Requirements Direc-
tive) could be separated from the balance sheet (IFRS), and banks could be permitted to use
other than market values for regulatory purposes. The third way would be to lower the
minimum capital requirements or make them more flexible (Basel II and the Capital Re-
quirements Directive). During the financial crisis, regulators used the first alternative.
Equity in company law. In company law, the terminology varies depending on the
governing law and may depend on the context.^21 In any case, the characterisation
of capital as equity or debt and capital instruments as equity or debt instruments
can depend on many overlapping regulatory objectives. Depending on the govern-
ing law, the main objectives can include: the alignment of accounting, tax and
company law requirements; the protection of other investors; and the protection of
shareholders in general and non-controlling shareholders in particular. In the EU,
the company law aspects of equity are heavily influenced by the European legal
capital regime. These questions will be discussed in the following sections.
(^14) Paragraph 49(iii) of the Basel II Accord.
(^15) Paragraph 49(i) and footnote 13 of the Basel II Accord.
(^16) Paragraph 49(iv) of the Basel II Accord.
(^17) Paragraph 49(v) of the Basel II Accord.
(^18) Paragraph 49(vii) of the Basel II Accord.
(^19) Paragraph 49(xi) of the Basel II Accord.
(^20) Paragraph 49(xii) of the Basel II Accord.
(^21) For English law, see, for example, Ferran E, Principles of Corporate Finance Law. OUP,
Oxford (2008) p 50: “[The term equity share capital] carries a precise meaning in par-
ticular contexts (such as that of the Companies Act 2006) but it is often used in a looser
sense to mean the same as share capital or, in the shortened form of equity, to mean
share capital, other undistributable reserves and retained earnings.”