Common Equity Tier 1 (CET1)
Candlefocus EditorCET1 comprises of primary bank capital, including publicly traded common stock, retained earnings and other capital reserves. CET1 is a key measure for assessing the amount of capital available for a bank to absorb losses. The amount of CET1 required by regulators is the amount of capital required to be held to support that bank’s risk profile. Banks must remain compliant with their CET1 requirements, as failure to do so can lead to severe penalties or restrictions being imposed on the bank by its regulator.
The CET1 ratio is the ratio of a Bank’s Common Equity Tier 1, divided by its total risk-weighted assets. It is a measure of the amount of assets a bank has available to absorb potential losses, relative to the total amount of assets it holds. The higher the ratio, the better the bank’s capital cushion.
The Capital Conservation Buffer was introduced by the Basel III framework in 2013, which implemented a set of global banking standards, and required banks to hold additional CET1 capital to provide a cushion against potential future losses. The buffer is essentially a ‘rainy day fund’ that should be held in the event of an economic slowdown or other market disruptions.
The importance of CET1 is highlighted in stress tests, which are regularly conducted to ensure that banks remain funds to survive an unexpected shock to their balance sheet. If a bank fails a stress test, it could be restricted by the regulator in terms of how much it can lend or how much dividends it can pay out.
In conclusion, CET1 is an important measure of a bank’s safety and soundness and serves as a form of capital cushion to help banks manage through different market conditions. For investors, CET1 is an important measure of the amount of capital a bank has available to manage risk and ensure that the bank is compliant with regulatory requirements.