Undisclosed Reserves: What It Is, How It Works

What Are Undisclosed Reserves?

Undisclosed reserves are unpublished or "hidden" reserves that may not appear on public documents, such as the balance sheet, but are still real assets acknowledged by most banking institutions.

Bank reserves are the minimum cash requirements that financial institutions must maintain to cover withdrawals. The Federal Reserve (Fed) establishes these requirements to ensure banks have sufficient funds on hand.

Key Takeaways

• Undisclosed reserves are included in a financial institution’s books but are hidden from the public and not listed on financial statements.
• Undisclosed reserves are part of Tier 2 capital, along with general loan-loss and revaluation reserves.
• Some countries do not recognize undisclosed reserves as assets according to their regulatory environments.

Understanding Undisclosed Reserves

Undisclosed reserves pertain to capital requirements in the banking industry and are classified as Tier 2 capital. Tier 2 is the supplementary layer of a bank’s capital and less liquid than Tier 1 capital.

Undisclosed reserves are included in Tier 2 capital through provisions or when a bank charges expenses against a Profit and Loss (P&L) statement. These items are not disclosed or visible on public statements, such as the balance sheet. Tier 2 capital also includes several crucial components of a bank’s capital requirement, typically consisting of:

• Undisclosed reserves
• Revaluation reserves
• General loan-loss reserves
• Hybrid debt-equity capital instruments
• Subordinated term debt

Tier 1 capital, also known as core capital, is more liquid and comprises equity capital and disclosed reserves (e.g., retained earnings). Tier 1 capital represents the funds available to a bank for lending, investing, trading, or other risky transactions. In simpler terms, Tier 1 funds support banks in absorbing losses without disrupting business operations.

Tier 1 and Tier 2 capital requirements were standardized in the Basel I accord, issued by the Basel Committee on Banking Supervision. These requirements remained unchanged in the Basel II accord. Many countries worldwide have implemented Tier 2 standards in local legislation. Tier 2 capital is capped at 100% of Tier 1 capital in regulatory capital calculations.

Undisclosed Reserves Special Considerations

Preferred or accepted forms of capital and collateral have gained significance, especially after the banking crisis of 2008 and 2009. Bank stress tests conducted in response to taxpayer-funded bailout programs revealed the inadequate nature of certain assets and reserves during the volatile markets of the Great Recession.

Undisclosed reserves are not commonly encountered but may be accepted by regulators when a bank has generated profits that have not been recorded in retained earnings or general reserves. Acceptance of undisclosed reserves as an accounting concept or valid form of capital varies across countries, as many do not recognize them.