Core capital is the highest-quality layer of a bank’s regulatory capital, the money that absorbs losses immediately while the bank keeps operating. Under the Basel III framework, core capital centers on Common Equity Tier 1, known as CET1, which must equal at least 4.5% of a bank’s risk-weighted assets. Mandatory buffers sit on top of that floor, so the practical requirement for most banks is around 7%, and larger or more systemic institutions must hold more.1
The reason regulators focus on this narrow slice of capital is loss absorption. Debt has to be repaid; common equity does not. A bank can burn through equity to cover bad loans and still keep its doors open, which is exactly the behavior the framework is designed to force. CET1 instruments have no maturity date and no mandatory payments, so their full value stays available at all times to cushion losses.
What Core Capital Is Made Of
CET1 is built from a short list of high-quality items that are fully subordinate to every other financial obligation the bank carries. The main components are common stock (including any share premium paid above par), retained earnings, and certain accumulated other comprehensive income items. These represent money that belongs to shareholders last in a liquidation, which is precisely why regulators count them first for capital purposes.
Common stock is the most direct loss absorber. If assets decline in value, the loss lands on the equity that shareholders hold. Retained earnings work the same way; they are accumulated profits the bank chose not to distribute, and they sit on the balance sheet ready to cushion future losses. Together, common stock and retained earnings typically make up the vast majority of a large bank’s CET1.
What Gets Deducted
Banks cannot simply add up their equity accounts and call the total CET1. Regulators require deductions to strip out items that look like capital on paper but would evaporate in a crisis. The most significant are goodwill and other intangible assets, deferred tax assets that depend on future profitability, and investments in unconsolidated financial institutions.
Goodwill represents the premium a bank paid when acquiring another company above the target’s book value. It sits on the balance sheet as an asset, but nobody can sell goodwill to cover depositor losses. Stripping it out prevents banks from inflating capital ratios with items that have little liquidation value. Deferred tax assets that depend on the bank earning future profits face a similar problem: if the bank is losing money, those tax benefits may never materialize.
Some items use a threshold approach instead of a full write-off. Significant investments in the common shares of unconsolidated financial companies, mortgage servicing rights, and deferred tax assets from temporary differences each receive limited recognition. Each is individually capped at 10% of the bank’s adjusted common equity, and all three together cannot exceed 15% of CET1. Anything above those limits gets deducted.
How the Ratio Is Calculated
Capital ratios would be meaningless without a denominator that reflects the actual risk on a bank’s books. That denominator is risk-weighted assets, or RWA. The formula is simple: CET1 Ratio = CET1 Capital ÷ Risk-Weighted Assets. The complexity lives inside the RWA calculation, which assigns every asset a risk weight based on how likely it is to generate losses.
Cash held at the bank carries a 0% risk weight, meaning it requires no capital backing at all. Government bonds from highly rated sovereigns (AAA to AA-) also receive a 0% weight. As credit quality drops, the weights climb: bonds from A-rated sovereigns carry 20%, and those rated BBB sit at 50%. Unrated corporate loans generally receive a 100% risk weight, requiring the bank to hold the full capital charge against them.
Residential mortgages vary by loan-to-value ratio. Under the Basel III standardized approach, a mortgage with an LTV of 50% or less carries a 20% risk weight, while a mortgage where the borrower owes more than the home is worth carries a 70% weight. The bank multiplies each asset’s exposure amount by its assigned weight, and the sum of those products is total RWA.
The result is a risk-adjusted picture of the balance sheet. A bank loaded with government bonds and cash will have far lower RWA than one with the same total assets concentrated in corporate lending. That difference shows up directly in capital ratios: banks taking more risk must hold more capital.
The Minimums and the Buffers That Sit on Top
Basel III sets three minimum capital ratios, each measured against RWA. CET1 must be at least 4.5%. Total Tier 1 capital (CET1 plus Additional Tier 1) must reach 6%. Total Capital (Tier 1 plus Tier 2) must hit 8%. These are hard floors. Breaching any of them triggers supervisory intervention.
The effective CET1 requirement is higher than 4.5% because of the Capital Conservation Buffer, set at 2.5% of RWA and met entirely with CET1. That brings the practical CET1 threshold to 7.0% for most banks. The buffer exists to be drawn down during stress, but a bank that dips into buffer territory faces graduated restrictions on capital distributions. At the bottom of the range, between 4.5% and 5.125%, the bank must conserve 100% of its earnings and can pay nothing in dividends, buybacks, or discretionary bonuses. The constraint loosens at each step until the ratio clears 7.0%, at which point no restrictions apply.
National regulators can layer a Countercyclical Capital Buffer on top during periods of excessive credit growth. This buffer varies by jurisdiction and adds another CET1 requirement when regulators see systemic risk building.
Global systemically important banks (G-SIBs) face an additional surcharge ranging from 1.0% to 3.5% of RWA, organized into five buckets based on size, interconnectedness, cross-border activity, and complexity. The top bucket has been intentionally left empty to discourage banks from growing more systemically important. For the largest G-SIBs in the second-highest bucket, the surcharge is 2.5%, pushing the effective CET1 requirement to 9.5% or more before any countercyclical add-on.
What Happens if a Bank Falls Short
In the United States, consequences go beyond buffer restrictions. The Prompt Corrective Action framework requires regulators to intervene with increasing severity as capital declines. An undercapitalized bank must submit a capital restoration plan within 45 days, and the regulator must act on that plan within 60 days of submission.
While operating under a shortfall, the bank faces hard constraints. It cannot let its average total assets grow beyond the prior quarter’s level unless the regulator has accepted its restoration plan and the growth is consistent with it. It cannot acquire interests in other companies, open new branches, or enter new lines of business without regulatory approval. Even management fee payments to controlling entities are barred if paying them would leave the bank undercapitalized.
Those restrictions explain why banks maintain capital ratios well above the regulatory minimums. The cost of falling short is not just financial; it is operational. A bank stuck under a capital restoration plan has effectively lost the ability to pursue any growth strategy, and that is often a stronger motivator than the dividend limits alone.
Where Core Capital Fits Alongside AT1 and Tier 2
Tier 1 capital is broader than CET1 alone. The second component is Additional Tier 1 (AT1) capital, which also absorbs losses while the bank is still operating but uses instruments that do not meet every CET1 criterion. The most common AT1 instruments are perpetual contingent convertible bonds, often called CoCos. These debt-like securities automatically convert into common equity or get written off entirely when the bank’s capital drops to a specified trigger point.
AT1 instruments must be perpetual, and coupon payments must be fully discretionary. The bank can skip a coupon without triggering a default. Beyond the contractual trigger, all AT1 instruments must also be capable of conversion or write-down at the point of non-viability, which occurs when the regulator determines the bank would fail without intervention or when public funds are injected to prevent failure.
The distinction matters for ratio calculations. The 4.5% CET1 minimum must be met with common equity alone. The broader 6% Tier 1 minimum can include both CET1 and AT1. Most large banks hold far more CET1 than the minimum, so AT1 instruments serve as a supplementary layer.
Tier 2 sits below both. Tier 1 is “going concern” capital, taking hits while the bank is still alive and operating. Tier 2 is “gone concern” capital, absorbing losses primarily when the bank is failing or being wound down. Tier 2 instruments include subordinated debt and certain hybrid securities. Unlike AT1, Tier 2 debt can have a maturity date, though it must have an original maturity of at least five years, and its recognized value amortizes in the final years before maturity. General loan-loss provisions also count toward Tier 2, subject to a cap.
The Simplified Path for Community Banks
The RWA calculations described above are complex and expensive to administer. Recognizing that smaller institutions lack the resources of global banks, U.S. regulators created the Community Bank Leverage Ratio (CBLR) framework as an alternative. Banks that opt into CBLR skip the risk-weighting process and instead maintain a single Tier 1 leverage ratio of 9% measured against average total consolidated assets.
Eligibility is limited to banks with total consolidated assets under $10 billion, average off-balance-sheet exposures of 25% or less of average total assets, and trading assets and liabilities of 5% or less of average total assets. Banks that meet these criteria and maintain the required leverage ratio are considered to have met all risk-based capital requirements, including buffer requirements, without performing any risk-weight calculations.
In 2025, the FDIC proposed lowering the CBLR threshold from 9% to 8%, which would allow more community banks to qualify for the simplified regime. If finalized, the change would be particularly significant for institutions that currently sit just below 9% and have been forced to maintain the full risk-weighted capital framework as a result.