TL;DR. A bank’s “capital ratio” is the cushion of equity-like funding it holds against its risky assets. Regulators slice that cushion into three tiers — Common Equity Tier 1 (CET1), Additional Tier 1 (AT1), and Tier 2 — each more loss-absorbent than the next. Under Basel III, big banks must hold at least 4.5% CET1, 6% Tier 1, and 8% Total Capital relative to risk-weighted assets, plus a stack of buffers that pushes the real-world minimum closer to 10–13% CET1 for U.S. global banks.
What “capital” means for a bank
Banks are leveraged by design. They fund long-dated loans with short-dated deposits and wholesale borrowing. When loans go bad, someone has to absorb the loss before depositors do — and that someone is the bank’s capital: equity, retained earnings, and a narrow set of debt-like instruments that can be wiped out without triggering bankruptcy. Bank capital is not the same as cash on hand or “reserves” at the Fed. Capital is a funding source; reserves are an asset. Confusing the two is the single most common error in banking-policy debates.
The capital ratio is simply:
Capital Ratio = Eligible Capital ÷ Risk-Weighted Assets (RWA)
The numerator is the cushion. The denominator weights each asset by how risky regulators believe it is — a Treasury bond gets a 0% weight, a residential mortgage roughly 50%, a leveraged corporate loan 100%, an off-the-run derivative exposure more than 100%. RWA is what makes “capital ratios” different from a plain debt-to-equity number you’d see at a non-bank.
The three tiers, stacked
Basel III defines three categories of capital, in descending order of loss-absorbency.
Common Equity Tier 1 (CET1) — the real cushion
CET1 is the gold standard: common stock, retained earnings, accumulated other comprehensive income, less goodwill and certain deferred tax assets. It absorbs losses first and continuously. Every other layer is built on top of it. When a bank says its CET1 ratio is “13.5%,” that single number is what credit analysts, rating agencies, and Fed examiners watch most closely.
Additional Tier 1 (AT1) — the contingent layer
AT1 capital is perpetual, deeply subordinated, and designed to absorb losses while the bank is still a going concern. The most famous AT1 instrument is the contingent convertible bond, or CoCo, which either converts to equity or gets written down when CET1 falls below a trigger (typically 5.125% or 7%). AT1 holders learned exactly how this works in March 2023, when Swiss regulator FINMA wrote down roughly $17 billion of Credit Suisse AT1 bonds to zero while the equity received a small recovery from the UBS takeover. That ordering surprised many investors and reset how AT1 spreads price subordination risk.
Tier 2 — the gone-concern cushion
Tier 2 is subordinated debt with at least five years’ original maturity. It absorbs losses only in resolution or liquidation — i.e., when the bank has already failed. Tier 2 is cheaper for banks to issue than equity but less protective for the system. Together, Tier 1 + Tier 2 = Total Capital.
The minimums (the headline numbers)
Here is the regulatory stack every internationally active bank must clear. The first three lines are global Basel III minimums; the buffers and surcharges are stacked on top and must be met with CET1.
| Requirement | Level (% of RWA) | Must be met with |
|---|---|---|
| CET1 minimum | 4.5% | CET1 only |
| Tier 1 minimum (CET1 + AT1) | 6.0% | CET1 + AT1 |
| Total Capital minimum (Tier 1 + Tier 2) | 8.0% | CET1 + AT1 + Tier 2 |
| Capital Conservation Buffer | +2.5% | CET1 |
| Countercyclical Buffer (cycle-dependent) | 0% – 2.5% | CET1 |
| G-SIB Surcharge (Basel framework) | +1.0% to +3.5% | CET1 |
| Tier 1 Leverage Ratio (non-risk-weighted) | 3.0% | Tier 1 |
In practice, a U.S. global systemically important bank like JPMorgan or Citi runs into three additional U.S.-specific layers on top of the Basel minimums: a Stress Capital Buffer (SCB) sized by the Fed’s annual stress test, a G-SIB surcharge (the U.S. uses a “Method 2” formula that can produce higher add-ons than the Basel global method), and a Supplementary Leverage Ratio (SLR) of at least 3% — enhanced to 5% at the holding-company level for the largest banks. Stack all of that up and the all-in CET1 floor for a U.S. G-SIB is typically in the 10% to 13% range, not 4.5%.
A simple worked example
Imagine a stylized regional bank with the following balance sheet:
- $100 billion in assets, of which $80 billion are loans, $15 billion are Treasuries, $5 billion is cash at the Fed.
- RWA calculation: Treasuries and cash at 0% = $0; loans at an average 75% weight = $60 billion. Total RWA = $60 billion.
- Capital stack: $7.2 billion common equity + retained earnings ($7.2B CET1), $0.9 billion of perpetual preferred stock (AT1), $1.2 billion of 10-year subordinated notes (Tier 2).
Ratios:
- CET1 ratio = $7.2B / $60B = 12.0% — well above the 4.5% minimum, and above a typical 7% effective floor including the conservation buffer.
- Tier 1 ratio = ($7.2B + $0.9B) / $60B = 13.5%.
- Total Capital ratio = ($7.2B + $0.9B + $1.2B) / $60B = 15.5%.
- Leverage ratio = Tier 1 / $100B total assets = 8.1%.
Notice the gap between the 12.0% CET1 ratio and the 8.1% leverage ratio. The first answers “how much do you hold against risk-weighted assets?” The second answers “how much do you hold against the whole balance sheet, ignoring risk weights?” The leverage ratio exists precisely because regulators do not fully trust risk weights.
The buffers: why “minimum” isn’t really the minimum
Buffers turn the hard minimum into a soft one. If a bank dips into its buffers, it doesn’t immediately fail — but it faces escalating restrictions on dividends, share buybacks, and discretionary bonuses (the regulatory term is Maximum Distributable Amount, or MDA). The deeper into the buffer, the more of the prior year’s earnings the bank must retain.
- Capital Conservation Buffer (2.5%). Always on. Designed so banks have a “rainy day” margin above the hard floor.
- Countercyclical Buffer (0–2.5%). Set by national regulators when they see credit booms. In the U.S., the Fed has kept it at 0%; the UK and several European regulators have used it actively.
- G-SIB Surcharge (1.0–3.5%, higher under U.S. Method 2). Scales with size, interconnectedness, complexity, cross-jurisdictional activity, and substitutability.
- Stress Capital Buffer (U.S. only, at least 2.5%). Sized each year by the Fed’s Dodd-Frank Act Stress Test (DFAST) based on the projected CET1 drawdown in the severely adverse scenario, plus four quarters of planned dividends.
The leverage ratio: a non-risk-weighted backstop
RWA is gameable. Banks can rotate from corporate loans (100% weight) into Treasuries (0% weight) and watch their RWA shrink without selling a single asset. The leverage ratio short-circuits that game by measuring Tier 1 capital against total leverage exposure, with no risk weights. Basel sets 3% as the global floor. The U.S. layers an enhanced version, the Supplementary Leverage Ratio, requiring 5% at the holding-company level for the eight U.S. G-SIBs and 6% at the insured-depository level. Critics argue the SLR penalizes banks for holding Treasuries — and on June 27, 2025 the Fed, OCC, and FDIC jointly proposed reducing it; under the proposal, aggregate Tier 1 capital requirements for affected holding companies would fall by “less than two percent.”
How the system is actually behaving
The Fed’s 2025 DFAST results, released June 27, 2025, give a current read on resilience. Twenty-two large banks were tested. Under the severely adverse scenario, projected losses topped $550 billion — $158 billion on credit cards, $124 billion on commercial and industrial loans, $52 billion on commercial real estate. Aggregate CET1 fell 1.8 percentage points. All twenty-two banks remained above their minimums. Vice Chair Michelle Bowman summarized: “Large banks remain well capitalized and resilient to a range of severe outcomes.”
Common mistakes and where the framework breaks
- Confusing capital with liquidity. Silicon Valley Bank failed in March 2023 with a CET1 ratio comfortably above its minimum. Capital ratios measure solvency. Deposit runs are a liquidity problem, governed by the LCR and NSFR — different rules entirely.
- Treating AT1 as bond-like. AT1 instruments are designed to absorb losses while the bank is still operating. Credit Suisse’s holders learned in 2023 that AT1 can be written down to zero before equity is fully wiped out, if the relevant regulator decides resolution requires it.
- Reading a single capital ratio in isolation. A 13% CET1 ratio at a bank with 30% of its loan book in commercial real estate tells you something very different from 13% at a bank dominated by prime residential mortgages. Risk weights are an average over the book, not a stress.
- Forgetting the buffer cascade. A bank can be “well above the minimum” and still be effectively prohibited from paying its planned dividend if it dips into the conservation buffer or SCB.
Related concepts to learn next
The capital framework sits inside a wider supervisory web. If you’ve followed this far, the next concepts worth your time are: risk-weighted assets and the standardized vs. internal-models approaches; the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) that govern bank liquidity; Total Loss-Absorbing Capacity (TLAC), which sits above Tier 2 and is designed to absorb losses in resolution; and the Fundamental Review of the Trading Book (FRTB), which rewrote market-risk capital after the 2008 crisis.
Sources
- Basel Committee on Banking Supervision — Basel III: international regulatory framework for banks
- Basel Committee — Basel III summary table (PDF, capital ratio minimums and buffers)
- Federal Reserve Board — Basel Regulatory Framework
- Federal Reserve Board — Dodd-Frank Act Stress Tests overview
- Federal Reserve Board — 2025 DFAST results press release (June 27, 2025)
- Federal Reserve Board — Proposal to modify the enhanced supplementary leverage ratio (June 27, 2025)
- Swiss Financial Market Supervisory Authority (FINMA) — Statement on the writedown of Credit Suisse AT1 instruments (March 23, 2023)
- Financial Stability Board — 2024 list of global systemically important banks
Disclosure: This article was produced with AI assistance and reviewed before publication. It is for informational purposes only and is not investment advice.