Common Equity Tier 1

Also called: CET1 · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

Common Equity Tier 1 (CET1) is a bank's best-quality capital: the owners' own money that can absorb losses right away while the bank keeps running. It is made up of common shares, share premium, retained earnings and disclosed reserves, and it is the core part of Tier 1 capital.

It matters because CET1 is the first money to take a loss when loans go bad. Under Basel III, it became the main test of how strong a bank really is.

CET1 ratio = CET1 capital ÷ Risk-weighted assets (RWA) × 100

Explanation

What goes into CET1

• Common shares: money the owners put in when they bought the bank's ordinary shares.
• Share premium: money paid above the face value of shares.

• Example: a share with a face value of Rs 10 is sold for Rs 50. The extra Rs 40 is share premium.

• Retained earnings: past profits the bank kept instead of paying them out as dividends.

• Disclosed reserves: reserves the bank shows openly in its accounts.
• What all four share: the bank never has to repay this money. It pays no fixed interest on it. So it can take losses without the bank failing.

Where CET1 sits in the capital structure

• Tier 1 capital is "going-concern" capital, meaning it absorbs losses while the bank is still running. It has two parts:
• CET1: the best quality.

• Additional Tier 1 (AT1): perpetual (no maturity date), non-cumulative (skipped interest is never paid later) bonds. They are written down or converted into equity if CET1 falls below a set trigger, or at the point of non-viability (PONV). PONV is when the regulator decides the bank cannot survive without help.

• Tier 2 capital is "gone-concern" capital. It absorbs losses mainly when the bank is closed down and its assets sold (liquidation). Examples are subordinated debt, general provisions and revaluation reserves.

• So the loss order is: CET1 first, then AT1, then Tier 2, and only after that depositors.
• Why Basel III stressed CET1:
• In the 2008 global financial crisis, many banks had capital that looked large on paper but was of poor quality.
• When losses came, that capital could not absorb them.
• Basel III (2010) therefore set a separate minimum for CET1, apart from the total capital rule.

What makes the CET1 ratio rise or fall

• Ratio rises when:
• the bank makes profits and keeps them (retained earnings go up)
• the bank issues new shares
• the government puts fresh capital into public sector banks (recapitalisation)

• the bank moves towards safer assets, such as G-secs with a 0% risk weight, so RWA falls

• Ratio falls when:

• Loans go bad → the bank sets money aside for the losses → profits fall or turn into losses → retained earnings shrink → CET1 falls.
• The bank pays large dividends, so less profit stays inside.
• Risky lending grows → RWA rises → the same CET1 now covers a bigger base → the ratio falls.

Worked example

• A bank has RWA = Rs 440.
• India's minimum CET1 is 5.5%. With the capital conservation buffer (CCB) of 2.5%, CET1 must be at least 8%, which is Rs 35.2.
• The bank's CET1 is Rs 30:
• CET1 ratio = 30 ÷ 440 × 100 ≈ 6.8%
• This is above 5.5%, so the bank meets the minimum.
• It is below 8%, so the bank is inside its buffer. It faces limits on dividends, bonuses and share buybacks until it rebuilds capital.

In India

• Regulator: the RBI applies the Basel norms through its Master Circular on Basel III Capital Regulations. Basel norms are not a treaty. They become binding only through the national regulator.
• Start date: Basel III capital rules took effect in India from 1 April 2013. Banks must meet the minimums on an ongoing basis. [1] Full phase-in came in October 2021, after several extensions, including during COVID-19.
• India is stricter than Basel III:

Requirement	Basel III	India (RBI)
Minimum CET1	4.5%	5.5%
CCB (must be held in CET1)	2.5%	2.5%
CET1 + CCB	7%	8%

• Buffers are held on top of CET1. The RBI's minimum CET1 does not include the capital conservation buffer or the countercyclical capital buffer (CCyB). [1]
• CCyB (0–2.5% of RWA): the RBI framework dates from 2015. In April 2022, the RBI said it was not necessary to activate it. [2]
• D-SIBs: Domestic Systemically Important Banks (banks "too big to fail") must hold extra CET1 on top of all these minimums.
• Latest figures for scheduled commercial banks (SCBs):
• CET1 ratio: 9.98% (March 2015) → 14.81% (March 2025) [4]

• CRAR: 12.94% → 17.36% over the same period [4]

• Stress tests: the RBI simulates a bad economy to test banks. In these tests, SCBs' total capital stays above the regulatory minimum even in adverse scenarios. The sector has adequate capital and liquidity buffers (Financial Stability Report, June 2026). [3]

• Why CET1 improved:
• government recapitalisation of PSBs
• NPA clean-up after the Asset Quality Review (2015) and the IBC (2016)
• higher profits kept inside the banks

Don't confuse with

• Additional Tier 1 (AT1): also Tier 1, but these are bonds, not equity. They absorb losses only when a trigger is hit or at PONV. CET1 takes losses first, automatically.
• Tier 2 capital: this is gone-concern capital, which absorbs losses mainly at liquidation. General provisions (up to 1.25% of credit RWA) count in Tier 2, not CET1.
• CRAR: this is (Tier 1 + Tier 2) ÷ RWA, with an India minimum of 9%. The CET1 ratio uses only the best capital, with a minimum of 5.5%.
• Leverage ratio: this is Tier 1 ÷ total exposure, with no risk weights. India requires 4% for D-SIBs and 3.5% for other banks. The CET1 ratio divides by risk-weighted assets.

Prelims Hooks

• CET1 = common shares + share premium + retained earnings + disclosed reserves. It is the highest-quality part of Tier 1.
• India's CET1 minimum is 5.5% (Basel III: 4.5%). With the 2.5% CCB it is 8% (Basel III: 7%).
• The CCB must be met with CET1 only. Breaching it limits dividends. It does not shut the bank.
• Trap: AT1 bonds are Tier 1 but not CET1. General provisions and revaluation reserves are Tier 2.
• The RBI's CET1 minimum excludes the CCB and CCyB. The buffers sit on top. Basel III applied in India from 1 April 2013. [1]
• SCBs' CET1 ratio was 14.81% in March 2025, up from 9.98% in March 2015. [4]

Mains Points

• Quality of capital, not just quantity:
• The 2008 crisis showed that banks with weak capital fail even when their headline ratios look fine.
• Basel III's focus on CET1, and India's stricter 5.5%, protect depositors in a system with a history of high NPAs.

• Linked reforms also matter: AQR (2015) found the losses, and IBC (2016) helped resolve them. Capital absorbs losses; resolution removes bad assets. Neither works alone.

• Safety versus credit growth:

• CET1 is equity, and equity costs a bank more than deposits.
• PSBs short of CET1 may cut lending, especially high-risk-weight MSME and unsecured loans. This happened in the Prompt Corrective Action (PCA) years of 2017-18.

• A balanced answer weighs the fiscal cost of recapitalising PSBs against the growth cost of tight credit.

• CET1 buffers as macroprudential tools:

• The CCB and CCyB are held in CET1. Macroprudential tools protect the whole financial system, not just one bank.
• They build capital in good times so banks can keep lending in bad times.
• The CCyB is still not activated. [2] Its main indicator, the credit-to-GDP gap, may not suit a fast-growing, under-banked economy, where credit rises naturally as more people get access to banks.

Related concepts

• Leverage
• Basel norms
• Basel I
• Basel II
• Three pillars of Basel
• Capital adequacy ratio
• Risk-weighted assets
• Tier 1 capital
• Additional Tier 1 capital
• Tier 2 capital

Read more

• Capital adequacy: Basel I to Basel III