Basel III Capital Adequacy Ratio: CET1 & Tier 1 Calculation for Your Bank

The Basel III Capital Adequacy Ratio (CAR) is the ratio of a bank eligible capital to its risk-weighted assets (RWA). The formula is: CAR = Capital / RWA x 100%. Basel III requires a minimum of 4.5% Common Equity Tier 1 (CET1), 6% Tier 1 capital and 8% total capital. Including the capital conservation buffer of 2.5%, the effective minimum requirement is 10.5%.

CET1 (Common Equity Tier 1) comprises ordinary shares and retained earnings. It represents the highest quality of capital. Tier 1 capital adds Additional Tier 1 (AT1) instruments such as contingent convertible bonds (CoCo bonds). Tier 2 capital (supplementary capital) consists of subordinated liabilities with a minimum maturity of five years. Basel III prioritises CET1 as the loss-absorbing buffer for going-concern operations.

Beyond the minimum ratios, banks face: the capital conservation buffer (CCB) of 2.5% CET1, the countercyclical capital buffer (0‑2.5% depending on economic conditions), the systemic risk buffer for globally systemically important banks (G-SIBs, 1‑3.5%) and institution-specific SREP add-ons from the supervisor. In total, requirements for large banks can exceed 13‑15%.

Risk-weighted assets (RWA) reflect the risk profile of a bank balance sheet. Each exposure is multiplied by a risk weight: sovereign bonds (0%), mortgages (35%), corporate loans (20‑150%). Banks can use the Standardised Approach (SA) or the Internal Ratings-Based approach (IRB). CRR III tightens the output floor to 72.5% of the Standardised Approach to limit model risk.

CRR III (effective 2025 in the EU) introduces the output floor of 72.5%, preventing IRB models from reducing RWA excessively. It also introduces new rules for the credit risk standardised approach, operational risk (new Standardised Measurement Approach, SMA) and market risk (FRTB). For many institutions, RWA and thus capital requirements will increase. Early capital planning is critical.

When the capital conservation buffer is breached, distribution restrictions apply: dividends, bonuses and share buybacks are limited. If the CET1 ratio falls below 4.5%, the supervisor (BaFin/ECB) orders corrective measures, from capital raising and risk reduction to resolution. AT1 instruments (CoCo bonds) may convert to equity at a CET1 trigger of 5.125%.

Strategies to improve the capital ratio include: retained earnings (strengthening CET1), issuance of AT1/Tier 2 instruments, RWA optimisation through better collateral valuation, securitisation of loan portfolios (STS securitisation), migration to IRB models, and reducing high-risk exposures. ADVISORI supports holistic capital planning including ICAAP and stress testing.

ADVISORI provides end-to-end advisory: gap analysis of current capital ratios vs. regulatory requirements, RWA calibration and data quality review, ICAAP documentation and stress test scenarios, implementation of automated regulatory reporting systems (COREP), CRR III readiness assessment and training for capital management teams. Our consultants combine deep regulatory expertise with technical implementation capability.