FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

Basel III Capital Requirements and Leverage Ratio Explained

Updated 11 October 2026 · Fact-checked

Basel III raised the quality and quantity of bank capital. Minimums are CET1 4.5%, Tier 1 6% and total capital 8% of RWA. A 2.5% conservation buffer and a 0–2.5% countercyclical buffer sit on top. A separate 3% leverage ratio divides Tier 1 by unweighted exposure. Compare each ratio with its threshold.

Understand Basel III Capital Reforms and Leverage Ratio

Before the global financial crisis, banks held capital that looked adequate on paper. Much of it could not absorb losses while the bank was still operating. Basel III responded in three ways: better capital, more capital, and a backstop that does not rely on risk weights.

Quality. The focus moved to Common Equity Tier 1 (CET1): common shares and retained earnings, less regulatory deductions such as goodwill. CET1 absorbs losses first and fully. Other Tier 1 (Additional Tier 1) must be loss-absorbing instruments with no maturity. Tier 2 is gone-concern capital that absorbs losses in resolution.

Quantity. Minimums are measured against risk-weighted assets (RWA): CET1 4.5%, Tier 1 6%, total capital (Tier 1 + Tier 2) 8%. Basel II had a much lower common equity requirement.

Buffers. The capital conservation buffer is 2.5% of RWA, made up of CET1. It is always in force. If a bank dips into it, it faces limits on dividends, share buybacks and bonuses, but it can keep operating. The countercyclical buffer (CCyB) is set by national authorities between 0% and 2.5% of RWA, also in CET1. It is raised when credit growth looks excessive and released in stress. It is applied to the bank's exposures by jurisdiction, so a bank's own rate is a weighted average of the rates in the countries where it lends. With both buffers at maximum, the CET1 requirement is 4.5% + 2.5% + 2.5% = 9.5%, before any G-SIB surcharge.

Leverage ratio. Because risk weights can be gamed or modelled wrongly, Basel III added a non-risk-based measure: Tier 1 capital divided by total exposure, with a minimum of 3%. Exposure includes on-balance-sheet assets and specified off-balance-sheet items and derivatives. It does not use risk weights. It is a backstop: it binds most for banks with large low-risk-weight portfolios.

Key formulas to remember

Minimum capital ratios (% of RWA): CET1 ≥ 4.5%; Tier 1 ≥ 6%; Total capital ≥ 8%; Pillar 1 minimums, before buffers. Tier 1 = CET1 + Additional Tier 1.
Capital conservation buffer: 2.5% of RWA, met with CET1; Falling inside it triggers distribution restrictions, not a breach of the minimum.
Countercyclical buffer: 0% to 2.5% of RWA, met with CET1; Set by national authorities. A bank's own rate is the exposure-weighted average across jurisdictions.
CET1 with buffers: 4.5% + 2.5% + CCyB = 7% to 9.5%; Excludes any G-SIB surcharge.
Total capital with buffers: 8% + 2.5% + CCyB = 10.5% to 13%; Buffers are CET1, but the total requirement is stated against RWA.
Leverage ratio: Tier 1 capital ÷ Total exposure measure ≥ 3%; Not risk-weighted. Equivalent to a maximum leverage of about 33.3 times.

How to solve Basel III Capital Reforms and Leverage Ratio questions

Most questions ask you to compute a ratio, compare it with a threshold, and state the consequence. Use this order.

1Identify what is given: CET1, Additional Tier 1, Tier 2, RWA and total exposure. Check whether amounts are already net of deductions.
2Pick the right numerator: CET1 for the common equity ratio, Tier 1 for the Tier 1 and leverage ratios, Tier 1 + Tier 2 for total capital.
3Pick the right denominator: RWA for the risk-based ratios, total exposure (no risk weights) for the leverage ratio.
4Compute each ratio as numerator ÷ denominator.
5Work out the applicable requirement: minimum plus 2.5% conservation buffer plus the bank's countercyclical rate.
6Compare. Below a minimum is a breach. Inside the buffer means automatic distribution limits. Above everything means no constraint.
7State the consequence or the shortfall in currency terms if asked: shortfall = (required ratio − actual ratio) × denominator.

Quickest way: Three-ratio scan

When to use it: Use when a question gives a balance sheet summary and asks which requirement is binding or breached.

Write the thresholds: 4.5, 6, 8 for RWA ratios; 2.5 buffer; 3 for leverage.
Compute CET1 ÷ RWA first. It is usually the binding one.
Add the buffers to 4.5% to get the CET1 target, and compare.
Compute Tier 1 ÷ exposure for leverage.
Eliminate options that mix up denominators or treat the buffer as a minimum.

Common mistakes in Basel III Capital Reforms and Leverage Ratio

Treating the conservation buffer as part of the minimum, so a bank inside it is called in breach.
Both are CET1 requirements and both are in the same table.
Fix: Minimum breach is below 4.5% CET1. Inside the buffer means restrictions on dividends, buybacks and bonuses only.
Using RWA as the denominator for the leverage ratio.
Every other ratio uses RWA, so students apply it by habit.
Fix: The leverage ratio uses unweighted total exposure. Its point is to ignore risk weights.
Using total capital as the leverage ratio numerator.
Confusion with the 8% total capital ratio.
Fix: Numerator is Tier 1 capital only.
Saying the countercyclical buffer is fixed at 2.5%.
It is confused with the conservation buffer.
Fix: CCyB ranges from 0% to 2.5% and is set by national authorities. It is often zero.
Mixing up when each buffer applies.
Both are described as buffers above the minimum.
Fix: Conservation is always on and is bank-wide. Countercyclical is time-varying, tied to the credit cycle and applied by jurisdiction of exposure.

Worked examples

Example 1

A bank has CET1 of $54 billion, Additional Tier 1 of $9 billion, Tier 2 of $12 billion and RWA of $600 billion. The conservation buffer is 2.5% and its countercyclical rate is 1.0%. Is the bank meeting its CET1 requirement including buffers, and what is the surplus or shortfall in $ billion?

Show the solution

CET1 ratio = 54 ÷ 600 = 9.0%.
CET1 requirement including buffers = 4.5% + 2.5% + 1.0% = 8.0%.
9.0% is above 8.0%, so the bank is compliant with no distribution limits.
Surplus = (9.0% − 8.0%) × 600 = 1.0% × 600 = $6 billion.

Answer: Yes. CET1 is 9.0% against a requirement of 8.0%, a surplus of $6 billion.

Example 2

A bank has Tier 1 capital of €30 billion, RWA of €300 billion and a total leverage exposure measure of €900 billion. How does it fare on the Tier 1 risk-based ratio (minimum 6%) and the 3% leverage ratio?

Show the solution

Tier 1 ratio = 30 ÷ 300 = 10.0%, above the 6% minimum.
Leverage ratio = 30 ÷ 900 = 3.33%, above the 3% minimum.
Margin over leverage minimum: 3.33% − 3% = 0.33%, which is 0.0033 × 900 ≈ €3 billion of Tier 1.
Note the low RWA density (300 ÷ 900 = 33%): the risk-based ratio looks strong while the leverage ratio is close to its floor.

Answer: Tier 1 ratio is 10.0% and leverage ratio is 3.33%. Both pass, but the leverage ratio is the tighter constraint, with about €3 billion of headroom.

Exam tips

Always check the denominator. The leverage ratio uses total exposure, not RWA.
Questions on buffers usually test consequences: distribution restrictions, not closure or automatic failure.
Know that buffers are met with CET1 and the CCyB is jurisdiction-weighted and set between 0% and 2.5%.
When RWA is small relative to exposure, expect the leverage ratio to be the binding constraint.
Do the arithmetic in percentages first, then convert to currency only if asked for a shortfall.

Practice questions from Solvency, Liquidity and Other Regulation After the Global Financial Crisis

Basel III Capital Reforms and Leverage Ratio in other exams

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

Basel III Capital Reforms and Leverage Ratio: frequently asked questions

What is the difference between the capital conservation buffer and the countercyclical buffer?

The conservation buffer is a fixed 2.5% of RWA in CET1, always in force, designed to be used in stress. The countercyclical buffer is 0% to 2.5%, set by national authorities and raised when credit growth is excessive. Both trigger limits on distributions if not met.

What are the Basel III CET1, Tier 1 and total capital minimums?

They are 4.5% CET1, 6% Tier 1 and 8% total capital, all as a share of RWA. With the 2.5% conservation buffer, the CET1 target becomes 7%, and the total capital target becomes 10.5%.

How is the Basel III leverage ratio calculated?

Divide Tier 1 capital by total exposure, which includes on-balance-sheet assets and certain off-balance-sheet and derivative exposures. No risk weights are applied. The minimum is 3%.

Why was a leverage ratio added to Basel III?

Risk-weighted ratios can understate risk if weights or models are wrong. The leverage ratio is a simple backstop that limits balance-sheet growth regardless of measured risk, and it reduces model risk and gaming.