Basel Capital Ratios
Executive Summary
Key Takeaways
- ✓ The Basel III framework defines three core capital ratios — CET1, Tier 1, and total capital — each measured against risk-weighted assets, with progressively wider eligible capital included at each tier.
- ✓ Minimum ratio requirements are layered with additional buffers — the capital conservation buffer, a countercyclical buffer that varies by jurisdiction and time, and, for certain institutions, a systemic-importance buffer — each of which should be modelled as its own named threshold.
- ✓ Breaching a buffer restricts discretionary distributions (dividends, certain bonus payments) rather than constituting an immediate breach of the hard regulatory minimum, a distinction the model should preserve rather than collapse into one figure.
- ✓ A bank model does not itself perform or validate a regulatory capital calculation; it should represent these ratios as the visible, sourced regulatory framework the balance sheet forecast is measured against.
- ✓ Basel ratio requirements are set at a minimum by the international framework but jurisdictions may apply additional, more stringent local requirements, which the model's threshold assumptions should reflect where relevant.
Objective¶
This guide sets out the Basel III capital ratio framework, within the Capital Adequacy Models technical guide, and how a bank model should represent each ratio and buffer as a distinct, named threshold.
The Three Core Ratios¶
| Ratio | Numerator | Typical Minimum |
|---|---|---|
| CET1 Ratio | Common Equity Tier 1 capital | Set by the applicable Basel/local framework |
| Tier 1 Ratio | CET1 + Additional Tier 1 capital | Set by the applicable Basel/local framework |
| Total Capital Ratio | Tier 1 + Tier 2 capital | Set by the applicable Basel/local framework |
Each ratio is measured against the same risk-weighted asset base, with progressively wider eligible capital included as the framework moves from CET1 through to total capital. See CET1 Modelling for the detailed build of the CET1 numerator specifically, and CET1 Ratio for the metric definition.
Capital Buffers¶
On top of the hard minimum ratios, the framework layers additional buffers:
- Capital conservation buffer — a fixed additional CET1 requirement above the minimum, applicable to all institutions under the framework.
- Countercyclical capital buffer — varies by jurisdiction and time, set by national authorities based on credit cycle conditions, intended to build up capital during periods of excess credit growth.
- Systemic-importance buffer — an additional requirement applied to institutions designated as systemically important, sized according to that designation.
Breaching a buffer, while remaining above the hard minimum, typically triggers restrictions on discretionary distributions — dividends, share buybacks, certain bonus payments — rather than constituting the more severe consequence of breaching the hard minimum itself. A model should represent minimums and buffers as distinct, separately labelled thresholds, so a reader can immediately see which type of consequence a given forecast scenario would trigger.
Jurisdictional Variation¶
The Basel framework establishes an international minimum baseline, but individual jurisdictions frequently apply additional, more stringent local requirements. A model's threshold assumptions should reflect the applicable local requirement where it exceeds the international minimum, sourced and labelled as such rather than defaulting silently to the international baseline.
What This Guide Does Not Cover¶
This guide describes how a model should represent the Basel ratio framework as visible, sourced input assumptions and thresholds. It does not describe FMAE performing or validating any specific regulatory capital calculation — that remains outside the structural audit engine's scope, consistent with Financial Modelling Best Practices for Banking.
Common Construction Pitfalls¶
- Collapsing the CET1, Tier 1, and total capital ratios into a single blended "capital ratio" figure, obscuring which specific tier a given constraint applies to.
- Modelling minimum ratios and buffers as a single combined threshold rather than distinct, separately labelled levels.
- Applying the international Basel minimum without checking whether a more stringent local requirement applies in the relevant jurisdiction.
- Presenting the model as though it validates regulatory capital compliance, rather than representing the framework as sourced input assumptions.
Continue Reading¶
Prerequisites¶
- Capital Adequacy Models — the parent guide
Related Technical Guides¶
Related Glossary¶
Related Industries¶
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Frequently Asked Questions
What are the three core Basel capital ratios?
The Common Equity Tier 1 (CET1) ratio, the Tier 1 ratio (CET1 plus additional Tier 1 capital), and the total capital ratio (Tier 1 plus Tier 2 capital), each measured against risk-weighted assets.
What capital buffers sit on top of the minimum ratios?
The capital conservation buffer (a fixed additional CET1 requirement above the minimum), the countercyclical capital buffer (which varies by jurisdiction and time based on credit cycle conditions), and, for certain systemically important institutions, an additional systemic-importance buffer.
What happens if a bank's capital ratio falls into a buffer but stays above the hard minimum?
Distribution restrictions typically apply — limits on dividends, share buybacks, and certain discretionary bonus payments — which is a materially different consequence than breaching the hard regulatory minimum itself, and the model should represent the two as distinct thresholds rather than a single blended requirement.
Does FMAE calculate or validate a bank's actual Basel capital ratios?
No — FMAE structurally audits a model's own formulas and logic. This guide describes how a model should represent the Basel ratio framework as visible, sourced input assumptions and thresholds, not how any specific regulatory capital calculation should itself be performed or validated.
Are Basel minimum requirements the same in every jurisdiction?
No — the Basel framework sets an international minimum baseline, but individual jurisdictions may impose additional, more stringent local requirements, and a model's threshold assumptions should reflect the applicable local requirement where it differs from the international minimum.
How does the CET1 ratio relate to CET1 Modelling?
This guide covers the ratio's place within the overall Basel framework; CET1 Modelling covers the detailed build of the CET1 numerator itself, including its specific eligibility criteria and deductions.
Related Articles
Capital Adequacy Models
Capital adequacy modelling represents the constraint regulatory capital requirements place on how much risk-weighted balance sheet a bank can carry against its available capital base. This guide covers how to structure a capital adequacy model — the capital tiers, the risk-weighted asset base they are measured against, minimum ratio and buffer requirements — and how it should be built as a live check against the balance sheet forecast rather than a standalone reporting exercise calculated after the forecast is already complete.
CET1 Modelling
Common Equity Tier 1 (CET1) capital is the highest-quality, most loss-absorbing layer of regulatory capital, and it is the numerator of the most closely watched Basel ratio. This guide covers how to build the CET1 capital base in a model: the eligible components (common shares, retained earnings, certain reserves), the regulatory deductions applied (goodwill, certain deferred tax assets, other intangibles), and how the balance should roll forward period over period as retained earnings and other capital actions occur.
CET1 Ratio
The CET1 ratio expresses Common Equity Tier 1 capital — a bank's highest-quality, most loss-absorbing capital — as a percentage of risk-weighted assets. It is the most closely watched capital adequacy metric under Basel III, subject to both a hard minimum requirement and additional capital buffers, and it should be built as a live output of the model's balance sheet forecast rather than a separately calculated reporting figure.
Risk Weighted Assets
Risk-weighted assets (RWA) convert a bank's balance sheet exposures into a common risk-adjusted base, applying higher weights to riskier exposures and lower weights to safer ones. RWA forms the denominator of every Basel capital ratio, making the risk-weighting methodology a first-order driver of reported capital strength. This guide covers the standardized and internal ratings-based (IRB) approaches to calculating RWA, how a model should build the RWA base from segmented exposures, and how risk-weight density should be tracked as its own diagnostic output.
Liquidity Coverage Ratio
The liquidity coverage ratio (LCR) tests whether a bank holds enough high-quality liquid assets to survive a defined 30-day acute stress scenario. This guide covers how to model the LCR's two components — the stock of high-quality liquid assets and net cash outflows under the stress scenario — and how the deposit and funding behavioural assumptions built elsewhere in the model feed directly into the outflow calculation.
Net Stable Funding Ratio
The net stable funding ratio (NSFR) tests whether a bank's longer-term assets are backed by a stable enough funding profile over a one-year horizon, complementing the short-term liquidity coverage ratio. This guide covers how to model the NSFR's two components — available stable funding, weighted by the behavioural stability of each funding source, and required stable funding, weighted by the tenor and liquidity of each asset — and how it connects to the balance sheet forecast and deposit modelling already built elsewhere in the model.