Common Equity Tier 1 (CET1)

Key takeaways
* CET1 is the highest-quality regulatory capital a bank holds to absorb losses as they occur.
* CET1 primarily consists of common equity: common shares, retained earnings, share premium, qualifying minority interest and accumulated other comprehensive income (AOCI).
* The CET1 ratio compares CET1 capital to a bank’s risk-weighted assets (RWAs). Basel III requires a minimum CET1 ratio of 4.5%.
* Tier 1 capital = CET1 + Additional Tier 1 (AT1). Total minimum capital under Basel is 8%, with at least 6% as Tier 1.

What is CET1?

Common Equity Tier 1 (CET1) is the core component of a bank’s capital used to absorb unexpected losses immediately when they occur. Introduced as part of the Basel III reforms after the 2007–2008 financial crisis, CET1 strengthens banks’ loss-absorbing capacity to protect depositors and financial stability.

Capital tiers overview
* Tier 1 capital — core capital used in going-concern scenarios; includes CET1 and AT1.
* Tier 2 capital — supplementary capital (e.g., subordinated debt, hybrid instruments) used in gone-concern scenarios.
* Tier 3 capital — lower-quality capital covering certain market and currency risks (less commonly used under modern frameworks).

Components of CET1
* Common shares and share premium (stock surpluses)
* Retained earnings
* Qualifying minority interest (common shares held by third parties)
* Accumulated other comprehensive income (AOCI), subject to regulatory adjustments

Additional Tier 1 (AT1)
AT1 consists of instruments that aren’t common equity but can absorb losses (for example, contingent convertible bonds or perpetual hybrids). AT1 securities often include provisions to convert to equity or be written down when CET1 falls below prescribed triggers.

How the CET1 ratio is calculated
CET1 Ratio = Common Equity Tier 1 Capital ÷ Risk-Weighted Assets (RWAs)

Risk-weighting adjusts asset values based on credit and market risk. For example, sovereign bonds may receive a 0% risk weight while higher-risk loans receive substantially higher weights. Under Basel III, banks must maintain a CET1 ratio of at least 4.5% of RWAs.

Regulatory minimums (Basel III)
* Minimum CET1 ratio: 4.5% of RWAs
* Minimum Tier 1 capital: 6% of RWAs
* Minimum total capital (Tier 1 + Tier 2): 8% of RWAs
Regulators may require additional buffers above these minimums, such as capital conservation and countercyclical buffers.

Special considerations
* Loss absorption order: CET1 is the first layer from which losses are deducted. If CET1 falls below regulatory minimums, the bank must rebuild capital or face regulatory action.
* Supervisory measures: Regulators can restrict dividends, share buybacks, and bonuses until capital ratios are restored.
* Stress testing: Authorities (e.g., the European Banking Authority, central banks) use CET1 as a principal measure in stress tests to assess banks’ resilience under adverse scenarios. Results inform supervisory actions and capital planning.

Explain CET1 simply
Banks have assets (loans, securities) and liabilities (deposits, borrowings). The difference—assets minus liabilities—is the bank’s capital, owned by shareholders. CET1 is the safest part of that capital (common equity and retained profits) and acts like a cushion to absorb losses so the bank can continue operating and protect depositors.

Common questions
* How is CET1 different from Tier 1?
CET1 is a subset of Tier 1. Tier 1 = CET1 + AT1.
* What does a low CET1 ratio indicate?
A low CET1 ratio suggests limited capacity to absorb shocks and may lead to regulatory constraints or recapitalization needs.
* What happens when CET1 falls below the minimum?
Banks must restore capital—often by raising equity, reducing assets, or curtailing payouts—and regulators may impose restrictions or intervene.

Bottom line
CET1 is the foundational measure of a bank’s capital strength. By focusing on common equity and retained earnings, the CET1 ratio provides a conservative view of a bank’s ability to withstand losses. Regulators use CET1 and related stress tests to ensure banks maintain sufficient buffers to protect depositors and financial stability.

Selected sources
* Bank for International Settlements — Basel III reforms and capital definitions
European Banking Authority — EU-wide stress test results
Federal Reserve and Federal Deposit Insurance Corporation materials on bank capital and regulatory requirements