Common equity tier 1 (CET1)

What is common equity tier 1 (CET1)’

The basic tier 1 (CET1) is part of tier 1 capital, which consists mainly of ordinary shares held by the Bank or other financial institution. It is the capital ratio, which was introduced in 2014 as a precautionary measure to protect the economy from the financial crisis. It is expected that all banks must meet a minimum ratio of cet1 in the amount of 4.50% by 2019.

Penetration ‘common equity tier 1 (CET1)’

After the financial crisis of 2008, the Basel Committee formulated the transformed set of international standards for the review and monitoring of capital adequacy of banks. These standards collectively known as Basel III, to compare assets from its capital, to determine if the Bank could withstand the test of crisis. The capital required of banks to absorb unexpected losses that arise in the ordinary course of business of the Bank. Basel III tightens capital requirements by limiting the type of capital that a Bank may include in its capital of different levels and structures. The capital structure of the Bank includes in tier 2 capital, tier 1 capital and total tier 1 capital (CET1) capital.

Calculation Of Tier 1 Capital

1 capital level is calculated as the tier 1 (CET1) capital and additional tier 1 capital (AT1). The base capital of the first level 1 includes the Bank’s share capital includes common shares, stock surplus as a result of the issue of ordinary shares, retained earnings, common shares issued subsidiaries and from third parties and other comprehensive income (AOCI). Additional tier 1 capital is defined as tools that are not common equity, but have the right to be included in this level. Example AT1 capital contingent convertible or hybrid security, which is indefinite and may be converted into capital, when there is a trigger event. The event that causes the security that needs to be converted to equity occurs when CET1 capital falls below a certain threshold.

CET1 is the measure of Bank solvency, which determines the strength of the Bank’s capital. This measure better captured the cet1 ratio, which measures Bank capital in relation to its assets. Since not all the assets have identical risks, assets acquired by the Bank is accounted for on a weighted basis, credit risk and market risk of each asset presents. For example, government bonds can be described as “risky assets” and subject to zero risk. On the other hand, subprime mortgage, can be attributed to high-risk assets and weighted 65%. In accordance with the Basel III capital and liquidity rules, all banks must have a minimum CET1 to risk-weighted assets ratio (EVR) in the amount of 4.50% by 2019.

Common Equity Ratio Tier 1 Capital=
Fixed Capital 1
Risk-Weighted Assets

The capital structure of the Bank consists of the Lower tier 2, upper tier 1, AT1 and CET1. CET1 is at the bottom of the capital structure, which means that in the event of a crisis, any losses incurred are deducted first from that level. If the deduction results in a cet1 ratio falls below the established minimum, the Bank needs to build its capital ratio to the desired level of risk or overtake or close the regulators. During the recovery phase, regulators may restrict banks from paying dividends and bonuses to employees. In case of bankruptcy, equity holders bear the losses for the mixed and holders of convertible bonds, and then tier 2 capital.

In 2016, the European Banking organization has conducted stress tests using the ratio of cet1 to understand how much capital the banks would leave in the unfortunate event of the financial crisis. The tests were made in the troubled period when many Eurozone banks are faced with a huge number of non-performing loans (npl) and reduction of stock prices. The test result showed that most banks would survive the crisis in 2016.

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