COMMON EQUITY TIER 1 (CET1)
Back to GlossaryDefinition
The core measure of a bank’s highest-quality capital—primarily common shares and retained earnings—relative to risk-weighted assets.
Summary
Common Equity Tier 1 (CET1) is a regulatory capital ratio that measures a bank's financial strength by comparing its highest-quality capital to its risk-weighted assets. Think of it as a safety cushion - it shows what percentage of a bank's risky investments are backed by the most reliable forms of money (like shareholders' investments and profits the bank has saved up). Banks must maintain a minimum CET1 ratio to operate legally, typically around 4.5-7% depending on regulations. A higher ratio indicates a stronger, safer bank that can better absorb losses.
Usage Context
Essential for understanding bank regulation, financial stability analysis, credit risk management, and regulatory compliance topics. Critical when studying Basel III framework and bank stress testing scenarios.
Common Confusions
- Confusing CET1 with total Tier 1 capital (CET1 excludes preferred shares and hybrid instruments)
- Thinking CET1 is calculated using book value of assets rather than risk-weighted assets
- Believing that retained earnings and common stock are weighted equally in the calculation
- Assuming a higher CET1 ratio always means better profitability (it actually may indicate conservative lending)
