FRM Exam Part II · Capital Structure in Banks

Basel III Capital Adequacy Ratios and Buffers Explained

Updated 11 October 2026 · Fact-checked

A capital adequacy ratio is regulatory capital divided by risk-weighted assets (RWA). Basel III sets minimums of 4.5% CET1, 6% Tier 1 and 8% total capital, then adds buffers: 2.5% conservation, 0–2.5% countercyclical, and a G-SIB surcharge. The leverage ratio (Tier 1 ÷ exposure measure, minimum 3%) is a non-risk-based backstop.

Understand Capital Adequacy Ratios and Buffers

Capital is the loss-absorbing cushion of a bank. A capital adequacy ratio compares that cushion with the risk the bank carries. The risk is measured by risk-weighted assets (RWA): each exposure is multiplied by a risk weight, so a riskier loan needs more capital than a safer one.

Basel III sets minimum ratios on RWA: Common Equity Tier 1 (CET1) at 4.5%, Tier 1 at 6% and Total capital at 8%. CET1 is the highest-quality capital: mainly common shares and retained earnings, after regulatory deductions. Tier 2 makes up the gap between Tier 1 and Total capital.

On top of the minimums sit buffers, all met with CET1. The capital conservation buffer (CCB) is 2.5% of RWA. It lifts the effective CET1 requirement to 7%. If a bank dips into the buffer, it is not closed down, but it faces limits on distributions such as dividends, buybacks and bonuses. The lower its CET1 falls within the buffer, the bigger the restriction on payouts.

The countercyclical capital buffer (CCyB) ranges from 0% to 2.5% of RWA. National authorities raise it when credit growth is excessive and release it in a downturn so banks can keep lending. For an internationally active bank it is a weighted average of the rates set in the jurisdictions where it has private-sector credit exposures. G-SIBs also hold a higher-loss-absorbency surcharge of 1% to 3.5% of RWA in CET1, depending on the bucket set by their systemic importance score.

Risk weights can be gamed or misjudged, so Basel III adds a leverage ratio: Tier 1 capital divided by a total exposure measure that is not risk weighted (on-balance-sheet and off-balance-sheet items). The minimum is 3%. G-SIBs also face a leverage ratio buffer set at 50% of their risk-based G-SIB surcharge. The two measures work together: the risk-based ratio is sensitive to risk, the leverage ratio is simple and hard to manipulate.

Key formulas to remember

Capital adequacy ratio: Capital ratio = Eligible capital ÷ RWA; Use CET1, Tier 1 or Total capital in the numerator to get the matching ratio. RWA is the same denominator for all three.
Minimum ratios (Pillar 1): CET1 ≥ 4.5%; Tier 1 ≥ 6%; Total capital ≥ 8% of RWA; These are before any buffer.
Capital conservation buffer: CCB = 2.5% of RWA, in CET1; CET1 requirement including CCB = 7%. Tier 1 = 8.5%. Total = 10.5%.
Countercyclical buffer: CCyB = 0% to 2.5% of RWA, in CET1; Bank-specific rate = exposure-weighted average of national CCyB rates, weighted by private-sector credit exposures by jurisdiction.
G-SIB surcharge: Surcharge = 1.0%, 1.5%, 2.0%, 2.5% or 3.5% of RWA, in CET1; Set by the bucket from the G-SIB score. Highest requirement (all buffers): CET1 = 4.5% + 2.5% + CCyB + surcharge.
Leverage ratio: Leverage ratio = Tier 1 capital ÷ Total exposure measure ≥ 3%; No risk weights. Exposure includes off-balance-sheet items and derivatives per the Basel rules. G-SIB leverage buffer = 50% of the G-SIB surcharge.
Total CET1 requirement: Required CET1 = 4.5% + CCB 2.5% + CCyB + G-SIB surcharge; Add the buffers to the 4.5% minimum, all measured on RWA.

How to solve Capital Adequacy Ratios and Buffers questions

Most questions ask you to compute a ratio, find the requirement a bank must meet, or say what happens if it falls short. Use this order.

1Identify what is asked: a ratio, a requirement, a shortfall, or a restriction on distributions.
2Write down the numerator and denominator. Risk-based ratios use RWA. The leverage ratio uses the total exposure measure.
3Check which capital tier belongs in the numerator: CET1, Tier 1 or Total capital.
4Build the requirement: minimum + CCB 2.5% + CCyB (if given) + G-SIB surcharge (if the bank is a G-SIB). Buffers are met with CET1.
5Calculate the bank's ratio and compare it with each requirement separately. Do CET1, Tier 1 and Total in turn.
6State the shortfall or surplus in percentage points and, if asked, in currency (gap % × RWA).
7Interpret: below the minimum is a breach. Inside the buffer means distribution limits, not a breach of the minimum. Leverage ratio can bind even when risk-based ratios look fine.

Quickest way: Stack the CET1 requirement, then test

When to use it: Use this when a question gives CET1 capital, RWA and some buffer rates and asks if the bank is compliant.

Add up the CET1 stack: 4.5% + 2.5% + CCyB + surcharge. This is your target.
Compute CET1 ÷ RWA once.
Compare. Above the target means no restriction. Between 4.5% and the target means distribution limits. Below 4.5% means a minimum breach.
For leverage questions, divide Tier 1 by exposure and compare with 3% (plus the G-SIB buffer if it is a G-SIB).
Eliminate options that put the buffer on top of Tier 1 or Total without noting that buffers are CET1.

Common mistakes in Capital Adequacy Ratios and Buffers

Using total assets instead of RWA as the denominator of the risk-based ratio.
Leverage ratio and capital ratio look alike, so the denominators get swapped.
Fix: Risk-based ratio uses RWA. Leverage ratio uses the exposure measure. Read the question for the word 'risk-weighted'.
Saying a bank breaching the conservation buffer must be closed or is below the minimum.
Students treat the buffer as part of the hard minimum.
Fix: Buffers are above the minimum. Breaching them triggers automatic restrictions on distributions, not a failure of the minimum requirement.
Adding buffers to the 6% Tier 1 or 8% Total ratios but meeting them with Tier 2 or AT1.
Students forget that buffers must be met with CET1.
Fix: Buffers are in CET1. CET1 used to meet the buffer cannot also count toward the 4.5% minimum twice.
Applying a domestic CCyB rate alone to an internationally active bank.
The rule seems like one country, one rate.
Fix: The bank-specific CCyB is a weighted average of rates in the jurisdictions of its private-sector credit exposures.
Thinking the leverage ratio uses risk weights or that a higher risk-based ratio guarantees a pass.
Both are capital ratios, so students assume they move together.
Fix: Leverage ratio has no risk weights. A bank with low-risk-weighted assets, such as sovereign bonds, can pass the risk-based test and still fail leverage.
Mixing G-SIB surcharge buckets with the countercyclical range.
Both are add-ons of a few percentage points.
Fix: CCyB is 0–2.5% and varies with the credit cycle. G-SIB surcharge is 1–3.5% and depends on systemic importance score.

Worked examples

Example 1

A bank has CET1 capital of $18 billion, Additional Tier 1 of $3 billion, Tier 2 of $5 billion and RWA of $200 billion. The CCyB is 1.0%. It is not a G-SIB. Does it meet the CET1 requirement including buffers?

Show the solution

CET1 ratio = 18 ÷ 200 = 9.0%.
Requirement = 4.5% + 2.5% + 1.0% = 8.0%.
9.0% is above 8.0%, a surplus of 1.0 percentage point.
Surplus in dollars = 1.0% × 200 = $2 billion of CET1.
Also check Tier 1: (18 + 3) ÷ 200 = 10.5%, above 6% + 2.5% + 1.0% = 9.5%. Total: (18 + 3 + 5) ÷ 200 = 13.0%, above 8% + 2.5% + 1.0% = 11.5%.

Answer: Yes. CET1 is 9.0% versus an 8.0% requirement, so there is no restriction on distributions, and a $2 billion CET1 surplus.

Example 2

A G-SIB has Tier 1 capital of €60 billion, a total exposure measure of €1,800 billion, CET1 capital of €45 billion and RWA of €500 billion. Its G-SIB surcharge is 2.0% and the CCyB is 0%. Check the CET1 requirement and the leverage ratio against a 3% minimum plus a leverage buffer of 50% of the surcharge.

Show the solution

CET1 ratio = 45 ÷ 500 = 9.0%.
CET1 requirement = 4.5% + 2.5% + 0% + 2.0% = 9.0%.
The bank exactly meets the requirement with zero surplus.
Leverage ratio = 60 ÷ 1,800 = 3.33%.
Leverage requirement = 3% + 50% × 2.0% = 4.0%.
3.33% is below 4.0%, a shortfall of 0.67 percentage points, or about €12 billion of Tier 1 (0.67% × 1,800 = approx. €12 billion; precisely 4.0% × 1,800 − 60 = €12 billion).

Answer: It meets the risk-based CET1 requirement exactly (9.0%), but its leverage ratio of 3.33% is below the 4.0% requirement. The shortfall is about €12 billion of Tier 1, so the leverage ratio is the binding constraint.

Exam tips

Memorise the stack: 4.5 / 6 / 8 for minimums, 2.5 for CCB, 0–2.5 for CCyB, 1–3.5 for G-SIB, 3 for leverage.
When a question mentions dividends, buybacks or bonuses, think conservation buffer and distribution restrictions.
Check the denominator every time. RWA for risk-based ratios and exposure measure for leverage.
Expect interpretation questions on why CCyB is released in a crisis: to avoid forcing banks to cut lending.
For leverage versus risk-based comparisons, ask which constraint binds. A bank with low average risk weights is usually leverage-constrained.

Practice questions from Capital Structure in Banks

Capital Adequacy Ratios and Buffers in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Capital Adequacy Ratios and Buffers: frequently asked questions

What are the Basel III capital buffers?

The capital conservation buffer is 2.5% of RWA. The countercyclical buffer is 0–2.5%, set nationally. G-SIBs also hold a surcharge of 1–3.5%. All are met with CET1.

How do you calculate a capital adequacy ratio?

Divide eligible capital by risk-weighted assets. Use CET1 for the CET1 ratio, Tier 1 for the Tier 1 ratio and Tier 1 plus Tier 2 for the total capital ratio. RWA is the sum of exposures times their risk weights, plus the capital charges for market and operational risk converted to RWA terms.

What is the difference between the leverage ratio and the risk-based capital ratio?

The risk-based ratio divides capital by RWA, so riskier assets need more capital. The leverage ratio divides Tier 1 by a non-risk-weighted exposure measure and has a 3% minimum. It acts as a backstop when risk weights understate risk.

What is the countercyclical capital buffer and when is it used?

It is an extra CET1 buffer of 0–2.5% of RWA that authorities raise when credit growth is excessive. They release it in a downturn so banks can absorb losses and keep lending. An internationally active bank applies a weighted average of the rates across its credit exposures.