CET1 Ratio
The Common Equity Tier 1 (CET1) Ratio is the primary measure of a bank's core capital adequacy under Basel III, calculated as CET1 capital — primarily common equity and retained earnings — divided by risk-weighted assets, with higher ratios indicating stronger capitalization.
The CET1 ratio is the most closely watched capital metric for US and global banks, used by regulators, rating agencies, and investors to assess financial strength and resilience to losses. Under Basel III as implemented in the US by the Federal Reserve, OCC, and FDIC, the minimum CET1 requirement is 4.5% of risk-weighted assets, plus additional buffers: a 2.5% capital conservation buffer and a Global Systemically Important Bank (G-SIB) surcharge of 1-3.5% for the largest US banks. The effective minimum for a bank like JPMorgan Chase may therefore be 11-12% CET1.
CET1 capital consists of common equity components: paid-in common stock, retained earnings, and accumulated other comprehensive income (AOCI), less regulatory deductions such as goodwill, certain deferred tax assets, and investments in financial entities above threshold amounts. Higher-quality components are favored because they absorb losses on a going-concern basis without triggering default or restructuring.
Risk-weighted assets (RWA) are the denominator — not total assets, but assets weighted by their credit risk, market risk, and operational risk. A US Treasury has a 0% risk weight; a corporate loan might carry 100%; an unrated small business loan or speculative-grade exposure can carry 100-150%. RWA calculations follow standardized approaches (formulaic weights set by regulation) or internal models (advanced approaches permitted for large US banks subject to supervisor approval). The adoption of Basel III endgame rules in the US, which would significantly revise RWA calculations, has been an ongoing regulatory discussion with material implications for large bank capital requirements.
US bank stress tests — the Federal Reserve's annual Dodd-Frank stress tests and Comprehensive Capital Analysis and Review (CCAR) — project CET1 ratios under severely adverse macroeconomic scenarios and determine capital distribution capacity (dividends and buybacks). A bank that would breach its required minimum CET1 under the stress scenario faces restrictions on capital returns.
For investors, rising CET1 ratios indicate capital accumulation and potential for increased shareholder returns; declining ratios may signal rapid loan growth, losses, or aggressive capital distribution. The CET1 ratio is also closely linked to bank stock valuations, with capital-generative banks commanded higher price-to-book premiums.