Common Equity Tier 1 · RiskAtoms Academy

By the end you will be able to

1List what counts as CET1: common shares, share premium, retained earnings and accumulated OCI.
2Apply the main deductions and filters: goodwill and software, DTAs, the cash flow hedge reserve, prudent valuation and the IRB expected loss shortfall.
3Apply the 10% and 15% thresholds to holdings in financials and DTAs, and the 250% risk weight to what is not deducted.
4Explain why each deduction exists, and what it does to a bank's ratio.

Why it matters

RiskAtoms Bank plc's accounts show £4,000m of equity. Its CET1 is £3,019.9m: only 75.5% of it. Some of the gap is AT1, which is a different kind of capital (L4.1.03: Additional Tier 1 and Tier 2). The rest, £580.1m, is assets the rules do not trust to be there in a crisis: goodwill from a past purchase, software, tax that needs future profits to recover. When a bank fails, these are the first things to be worth nothing.

Core explanation

What counts, and what comes off

What counts

L1.8.06: Capital, equity and leverage met CET1 as shares and retained earnings, less deductions. CAP10.6 lists the CET1 elements: common shares that meet CAP10.8's 14 criteria, the share premium on them, retained earnings, accumulated OCI and other disclosed reserves, and eligible minority interest. The first criterion says it all: the instrument must be the most subordinated claim in liquidation. CET1 is what is left for the owners after everyone else is paid.

Illustrative dataRiskAtoms Bank plc's capital book

The same made-up UK bank as Level 3: £67bn of assets and £4bn of equity at 31 December 2025, in £ millions. Module 4.1 adds its regulatory layer: own funds, deductions, risk-weighted assets by risk type, buffers, the leverage exposure and MREL, computed from the Level 3 credit, trading, derivatives and operational risk books. Every figure is illustrative, not any bank's data.

Pro forma. The book applies Basel 3.1, the 2017 finalisation of Basel III, to the 31 December 2025 balance sheet. On that date the bank still reported under the old UK CRR. The UK applies Basel 3.1 from 1 January 2027, and the internal model approach for market risk from 1 January 2028 (PRA PS1/26, paras 1.23 and 1.24). So the book shows the bank as it would look under the new rules.

CET1 element (CAP10.6)	£m
Ordinary shares and share premium	1,200
Retained earnings	2,380
FVOCI reserve (unrealised losses on bonds)	−20
Cash flow hedge reserve	40
Ordinary shareholders' equity	3,600

The FVOCI reserve is a loss of £20m on bonds held at fair value through OCI. It stays in CET1: Basel counts accumulated OCI, gains and losses alike. The bank's £400m of AT1 is also equity in the accounts, but it is not a CET1 element. It ranks ahead of the ordinary shares, so it fails the first criterion.

What comes off: the book's bridge

CAP30 then adjusts this figure. Most adjustments are deductions; a few are filters that remove an accounting gain or loss. On the book:

Step	Rule	£m
Accounting equity (IFRS)	m3-5	4,000.0
AT1 (equity in the accounts, not CET1)	CAP10.8	−400.0
Ordinary shareholders' equity	CAP10.6	3,600.0
Goodwill and software	CAP30.7	−500.0
DTAs from tax losses	CAP30.9	−30.0
Cash flow hedge reserve (filter)	CAP30.11	−40.0
Prudent valuation (AVAs)	CAP50.14; CRR Art 34	−10.1
IRB expected loss shortfall	CAP30.13	0.0
Holdings in financials above 10%	CAP30.22–30.26	0.0
Threshold items above 10% / 15%	CAP30.32–30.33	0.0
CET1	CAP10.2	3,019.9

Four of these need a closer look.

Goodwill and software, £500m: CAP30.7 deducts goodwill and all other intangibles, net of any deferred tax liability that would vanish if they were written off. The book has £300m of goodwill and £200m of capitalised software, and no such liability.
Deferred tax assets: the £30m from tax losses carried forward is deducted in full (CAP30.9), because it only turns into cash if the bank makes taxable profits again. The £60m from temporary differences is a threshold item.
Prudent valuation, £10.1m: Basel requires valuation adjustments for less liquid positions to reduce Tier 1 (CAP50.14), and the UK and EU take these AVAs off CET1 (CRR Article 34). The book uses an illustrative 0.1% of its £10,060m of fair-valued assets. L4.7.09: Prudent valuation has the real method.
The IRB expected loss shortfall, zero here. An IRB bank compares its one-year L3.3.10: Expected loss expected loss with its eligible provisions. If EL is larger, the shortfall comes off CET1 (CAP30.13). On the book EL is £97.3m against provisions of £179.4m: an excess of £82.1m, not a shortfall. IFRS 9 provisions include lifetime losses on stage 2 loans, while EL is one year. The excess goes to Tier 2, up to 0.6% of IRB credit RWA: 0.6% × £12,461.0m = £74.8m, so the cap binds (CAP10.19, L4.1.03: Additional Tier 1 and Tier 2). L4.2.07: Expected loss, provisions and the shortfall works the test in full.

Holdings in other financials: the 10% and 15% thresholds

A bank that owns shares in another bank or insurer holds capital that also counts in that company's books. Counted twice, it is double gearing: a loss in either firm hits both. Reciprocal cross-holdings designed to inflate capital are deducted in full (CAP30.21). Other holdings are deducted only above limits set as shares of CET1 after the other adjustments, here £3,019.9m:

Item on the book	Held	Limit	Risk weighted
Non-significant holdings: listed bank and insurer shares (CAP30.22–30.26)	120	10%: 302.0	120 at 250%
Significant investment: 30% of an asset manager (CAP30.29–30.31)	100	10%: 302.0
DTAs from temporary differences (CAP30.32)	60	10%: 302.0
The two threshold items together (CAP30.33)	160	15%: 453.0	160 at 250%

Nothing is deducted. But nothing is free either: the £160m of threshold items carries a 250% risk weight (CAP30.34), so £400m of RWA. The £120m of non-significant holdings stays in the banking book as equity at 250%: another £300m. The asset manager stake is a significant investment. The third threshold item in Basel, mortgage servicing rights, is not on the book.

Sort it

Sort itWhere does each item go?

For each item, choose how CET1 treats it under the Basel Framework.

Retained earnings from last year
Unrealised losses on FVOCI bonds
Capitalised software
The bank's own shares, held for an employee scheme
A surplus in the defined benefit pension fund
Gains on the bank's own debt as its credit worsens
A positive cash flow hedge reserve
A 15% stake in a listed insurer

Why each one exists

The reason behind the rule

The formal version

With $E$ the sum of the CET1 elements (CAP10.6), $D_k$ the deductions and filters applied in full, and $H$ the non-significant holdings:

\begin{aligned} C' &= E - \sum_k D_k \\ D_H &= \max\big(0,\ H - 10\%\, C'\big) \qquad \text{(CAP30.26)} \\ C^{*} &= C' - D_H \end{aligned}

Then the threshold items: significant investments in common shares $S$ and DTAs from temporary differences $T$ (CAP30.32 to 30.34).

On the book, in £ millions:

\begin{aligned} C' &= 3{,}600 - 500 - 30 - 40 - 10.06 - 0 = 3{,}019.94 \\ D_H &= \max\big(0,\ 120 - 301.99\big) = 0 \\ D_S &= \max\big(0,\ 100 - 301.99\big) = 0, \quad D_T = \max\big(0,\ 60 - 301.99\big) = 0 \\ D_A &= \max\big(0,\ 160 - 452.99\big) = 0 \\ \text{CET1} &= \text{£}3{,}019.94\text{m}, \qquad \frac{\text{CET1}}{\text{RWA}} = \frac{3{,}019.9}{22{,}807.7} = 13.24\% \end{aligned}

CAP30.33 sets the 15% against CET1 after all adjustments, including the threshold deductions themselves. Some rulebooks therefore write it as 15/85 = 17.65% of CET1 before them. The book applies 15% to $C^{*}$ , the more cautious reading; with £160m against a limit above £453m, the choice changes nothing here.

Try it

Move the items between equity and CET1. How large must the asset manager stake grow before any of it is deducted? Now take a loss of £1,500m: what happens to the limits, and to the room under them?

Try itFrom equity to CET1

Goodwill and software£500m

DTAs from tax losses£30m

DTAs from temporary differences£60m

Significant investments in financials£100m

Non-significant holdings in financials£120m

Loss taken through retained earnings£0m

The limits, set by CET1 after the other deductions (£3,019.9m)

Non-significant holdings vs 10%£120m vs limit £302m

Significant investments vs 10%£100m vs limit £302m

DTAs from temporary differences vs 10%£60m vs limit £302m

Both threshold items, after the 10% tests, vs 15%£160m vs limit £453m

Dashed line: the limit. Red: the excess is deducted from CET1.

CET1£3,019.9m

CET1 ratio13.24%

Total deductions and filters£580.1m

Of which above the thresholds£0.0m

Holdings risk weighted (RWA added)£700m

RWA (floor binds?)£22,808m (yes)

Change in CET1 ratio0.00 points

Cash flow hedge reserve, prudent valuation and the expected loss test stay at the book's values. The 15% test is applied to CET1 after the other deductions, as in the book. Illustrative data, £ millions.

Worked example

Buying a stake in an insurer

The board considers paying £250m in cash for a 25% stake in a listed insurer, on top of the 30% stake it already holds in an asset manager. Both are significant investments in common shares. £ millions.

A £250m significant investment

Step 1 of 5

1
The limits do not move
The 10% and 15% limits are set by CET1 after the other adjustments, £3,019.9m. The cash paid was central bank reserves at 0%, so nothing else changes. The limits stay at £302.0m and £453.0m.

Regulatory lens

The deductions are in CAP30 of the Basel Framework, which has been in force since the Basel III definition of capital. Each jurisdiction writes them into its own law, with a few differences that matter.

In the UK and the EU

Prudent valuation is a CET1 deduction under CRR Article 34 (in the UK, Article 34 of the PRA Rulebook's Own Funds (CRR) Part since 1 January 2026). Software differs: since 23 December 2020 the EU's CRR has not deducted all software assets (Article 36(1)(b)). The PRA said that month that it found no credible evidence software absorbs losses in stress and intended to keep the full deduction. It did so from 1 January 2022 (PS17/21). The book deducts software in full, as Basel and the UK do.

In the US

Banks that are not advanced approaches institutions may make a one-time election to opt out of accumulated OCI: unrealised gains and losses on available-for-sale securities then do not reach CET1 (12 CFR 217.22(b)(2)). Basel has no such option.

Spark Atoms

Spark AtomA quarter of the equity does not count

Of RiskAtoms Bank plc's £4,000m of equity, £400m is AT1 and £580.1m is removed by CAP30. CET1 keeps 75.5%. Goodwill and software alone are 86% of the adjustments: a bank that grows by buying others pays for it in CET1.

Spark AtomThe hedge reserve filter cuts both ways

CAP30.11 deducts a positive cash flow hedge reserve and adds back a negative one. The book's £40m is a gain, so CET1 is £40m lower. If rates moved the other way and the reserve turned into a loss of the same size, CET1 would be higher by that amount. The aim is a CET1 that does not move with one half of a hedge.

Key takeaways

CET1 is common shares, share premium, retained earnings and accumulated OCI (CAP10.6), less the adjustments of CAP30. It must be the most subordinated claim (CAP10.8).
On the book, £3,600m of ordinary equity becomes £3,019.9m of CET1 after £580.1m of deductions and filters.
Goodwill and intangibles, DTAs from tax losses, own shares and pension surpluses are deducted; the cash flow hedge reserve and own-credit gains are filtered.
Prudent valuation (£10.1m) and any IRB expected loss shortfall come off CET1; the book has an excess of provisions, £82.1m, instead.
Holdings in financials and DTAs from temporary differences are deducted only above 10% and 15% of CET1; the rest is risk weighted at 250%. The book's £160m of threshold items adds £400m of RWA.
Every deduction removes something that would not absorb losses in a crisis, or that would count capital twice.

Reaction

Check what stuck

Question 1 · objective 2

A bank has £10,000m of ordinary equity and no AT1. It has £800m of goodwill, £150m of DTAs from tax losses and a cash flow hedge reserve of +£50m. Nothing else needs adjusting. What is its CET1, in £m?

£m

Question 2 · objective 3

After all other adjustments a bank's CET1 is £5,000m. It holds a £700m significant investment in an insurer's shares and £300m of DTAs from temporary differences. How much is deducted under the 10% and 15% thresholds, in £m?

£m

Question 3 · objective 2

An IRB bank's expected loss is £500m and its eligible provisions are £420m. How much is deducted from CET1 for the shortfall, in £m?

£m

Question 4 · objective 4

Why are DTAs from tax losses deducted in full, while DTAs from temporary differences are deducted only above the thresholds?

ATax losses can only be used if the bank makes profits again; temporary differences reverse with less doubt, so they get a limited allowanceBTax losses are larger by definitionCTemporary differences are guaranteed by the governmentDThere is no difference: both are deducted in full under Basel

Question 5 · objective 1

RiskAtoms Bank plc's FVOCI reserve is −£20m: unrealised losses on bonds. Under the Basel Framework, what happens to it in CET1?

AIt stays in: accumulated OCI is a CET1 element, losses included, so CET1 is £20m lowerBIt is filtered out, like the cash flow hedge reserveCIt is moved to Tier 2DIt is added back, because the losses are unrealised

Glossary

CET1: Common Equity Tier 1: common shares, share premium, retained earnings and accumulated OCI, less the regulatory adjustments of CAP30. The capital that absorbs losses first.
Accumulated OCI: Accumulated other comprehensive income: gains and losses that bypass profit and sit in reserves, such as unrealised changes on bonds held at fair value through OCI.
Deduction: An amount taken off CET1 because the asset behind it would be worth little in a crisis, or because counting it would count capital twice.
Prudential filter: A prudential filter: an accounting gain or loss removed from CET1 because it does not reflect real loss-absorbing capacity, such as the cash flow hedge reserve.
Deferred tax asset: Deferred tax asset: tax the bank expects to save in future. Those from past tax losses need future profits to be used, so they are deducted in full.
DTA from temporary differences: A DTA from a temporary difference between accounting and tax values, such as provisions not yet tax-deductible. A threshold item, deducted only above the limits.
Additional valuation adjustment: Additional valuation adjustment: a prudent haircut on fair-valued positions for valuation uncertainty, close-out costs and model risk. Taken off CET1 in the UK and EU (CRR Article 34).
Expected loss shortfall: IRB expected loss shortfall: the amount by which a bank's IRB expected loss exceeds its eligible provisions. Deducted from CET1 (CAP30.13).
Non-significant investment: A non-significant investment: 10% or less of a financial company's common shares, outside the bank's consolidation. Deducted only above 10% of the bank's CET1.
Significant investment: A significant investment: more than 10% of a financial company's common shares, or an affiliate. Common shares get the threshold treatment; other capital instruments are deducted in full.
Threshold deductions: The 10% and 15% limits of CAP30.32 to 30.33: certain items count in CET1 up to these shares of CET1, and are risk weighted at 250% instead of deducted.
Double gearing: Double gearing: the same capital counted twice, once by the bank that invests and again by the financial company it invests in.

Deep Dives & Origins

Deep Dives

Basel Committee on Banking Supervision, CAP30: Regulatory adjustments, bis.org: every deduction with its rationale paragraph, and the FAQs beneath. Intermediate.
Prudential Regulation Authority, “PRA statement on the EU requirement on prudential treatment of software assets”, 30 December 2020. Introductory.

Origins

Basel Committee on Banking Supervision, CAP10: Definition of eligible capital, paras 10.6 and 10.8 (version effective 15 December 2019), bis.org.
Basel Committee on Banking Supervision, CAP30: Regulatory adjustments, paras 30.7–30.34 (version effective 15 December 2019), bis.org.
Basel Committee on Banking Supervision, CAP50: Prudent valuation guidance, paras 50.12–50.14, bis.org.
Basel Committee on Banking Supervision, CAP10, para 10.19 (excess provisions in Tier 2), bis.org.
Regulation (EU) No 575/2013 (CRR), Article 34, as retained in UK law, legislation.gov.uk (version of 1 January 2022; revoked from 1 January 2026 and restated in the PRA Rulebook's Own Funds (CRR) Part, PS12/25).
Prudential Regulation Authority, “PRA statement on the EU requirement on prudential treatment of software assets”, 30 December 2020.
Prudential Regulation Authority, PS17/21 Implementation of Basel standards, July 2021, chapter 6 (deduction of software assets from CET1).
US Code of Federal Regulations, 12 CFR 217.22(b)(2), eCFR, as at 22 October 2026.

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