Basel III CET1 Ratio

The Basel III Common Equity Tier 1 (CET1) Ratio is a central component of the Basel III regulatory framework and represents the highest quality measure of a bank’s capital strength. Introduced after the global financial crisis, the CET1 ratio focuses on the most loss-absorbing form of capital to ensure that banks are capable of withstanding periods of severe financial stress. In the context of banking, finance, and the Indian economy, the CET1 ratio has played a vital role in strengthening balance sheets, improving financial stability, and reinforcing confidence in the banking system.
The emphasis on CET1 under Basel III reflects a shift in regulatory philosophy from merely meeting numerical capital targets to ensuring the quality, permanence, and loss-absorbing capacity of bank capital. For India, the adoption of CET1 norms has been a key step in aligning domestic banking regulation with global standards while addressing country-specific structural and developmental considerations.

Concept and Meaning of the CET1 Ratio

The CET1 ratio measures a bank’s core equity capital in relation to its risk-weighted assets. It represents the proportion of a bank’s most reliable capital available to absorb losses without triggering insolvency. Unlike earlier frameworks that allowed a larger share of hybrid or debt-like instruments, Basel III places primary reliance on common equity.
CET1 capital mainly includes:

• Equity share capital
• Stock surplus arising from issue of shares
• Retained earnings
• Other disclosed reserves

Items such as goodwill, deferred tax assets, and other intangible assets are deducted to ensure that only high-quality, tangible capital is counted. This strict definition enhances the credibility and effectiveness of the capital base.

Regulatory Requirements under Basel III

Basel III significantly raised the minimum CET1 requirement compared to earlier norms. Banks are required to maintain a minimum CET1 ratio of 4.5 per cent of risk-weighted assets. In addition to this minimum, banks must hold a Capital Conservation Buffer composed entirely of CET1 capital, bringing the effective CET1 requirement to a higher level during normal economic conditions.
The objective of this enhanced requirement is to ensure that banks accumulate capital during good times so that it can be drawn down during periods of stress. This reduces the probability of bank failure and the need for public sector intervention.

CET1 Ratio and Risk-Weighted Assets

The CET1 ratio is calculated by dividing CET1 capital by risk-weighted assets. Risk-weighted assets represent the bank’s total exposures adjusted for credit, market, and operational risks. Assets with higher risk attract higher risk weights, thereby increasing capital requirements.
This risk-sensitive approach encourages banks to improve credit appraisal, diversify portfolios, and avoid excessive exposure to high-risk assets. In practice, the CET1 ratio acts as both a prudential safeguard and a strategic constraint influencing lending behaviour and balance sheet composition.

Implementation of CET1 Norms in the Indian Banking System

In India, the adoption of Basel III CET1 norms was undertaken in a phased manner to allow banks to adjust to higher capital standards. Indian banks were required to maintain CET1 ratios above the global minimum, reflecting a conservative regulatory stance aimed at safeguarding financial stability.
Public sector banks, which dominate the Indian banking system, faced significant challenges in meeting CET1 requirements due to legacy issues such as non-performing assets and lower internal capital generation. As a result, capital infusion by the government and market-based capital raising became essential to maintain compliance.
Private sector banks generally adapted more quickly, supported by stronger profitability, better asset quality, and access to capital markets. Overall, the implementation process contributed to improved capital discipline across the banking sector.

Impact on Banking and Financial Practices

The introduction of the CET1 ratio fundamentally changed capital planning and risk management practices in Indian banks. Greater emphasis was placed on internal capital generation through retained earnings, cost efficiency, and asset quality improvement. Banks became more cautious in expanding risk-weighted assets without corresponding capital support.
The focus on high-quality capital strengthened balance sheets and enhanced the ability of banks to absorb credit losses. It also improved transparency and comparability of capital positions across institutions, reinforcing market confidence.
However, higher CET1 requirements increased the cost of capital and constrained aggressive lending, particularly in capital-intensive sectors. This reinforced the importance of efficient credit allocation and risk-based pricing in banking operations.

Implications for the Indian Economy

At the macroeconomic level, stronger CET1 ratios contributed to greater financial stability in India. Well-capitalised banks are better positioned to support economic activity during downturns, maintain depositor confidence, and reduce systemic risk. This stability is crucial for a developing economy where banks play a central role in financial intermediation.
At the same time, concerns have been raised that stringent CET1 requirements may limit credit growth, especially for infrastructure projects and small enterprises. To address this, regulatory implementation has been calibrated to balance prudential strength with developmental needs.