After the global financial crisis of 2007–2008, regulators around the world realized something important: many banks simply didn’t have enough of their own money set aside to absorb losses when things went wrong. That realization led to Basel III, a global set of banking rules designed to make banks safer and more resilient.
One of the most important rules under Basel III is the minimum capital adequacy ratio. Let’s break down what that means, why it matters, and how it works—using plain language and simple examples.
What Is the Capital Adequacy Ratio (CAR)?
The capital adequacy ratio measures how much financial cushion a bank has compared to the risks it’s taking.
In simple terms, it answers this question:
If some of the bank’s loans go bad, does the bank have enough of its own money to cover the losses?
The ratio compares:
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The bank’s capital (its own money), and
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Risk-weighted assets (RWA), which reflect how risky the bank’s loans and investments are
The higher the ratio, the better prepared the bank is to handle financial stress.
The Minimum Requirement Under Basel III
Under Basel III, banks must maintain:
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At least 8% total capital relative to their risk-weighted assets
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Plus an extra 2.5% capital conservation buffer
That brings the effective minimum to 10.5%.
This buffer acts like a savings account for tough times. Banks are expected to build it up during good economic periods so they can draw on it during downturns instead of cutting back sharply on lending.
How Bank Capital Is Structured
Not all capital is treated the same. Basel III divides bank capital into tiers based on quality and reliability.
Tier 1 Capital (Core Capital)
This is the strongest and most reliable form of capital. It includes:
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Common stock
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Retained earnings
Under Basel III:
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Common Equity Tier 1 (CET1) must be at least 4.5% of RWA
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Total Tier 1 capital must be at least 6% of RWA
This capital absorbs losses while the bank continues operating.
Tier 2 Capital (Backup Capital)
This includes items like subordinated debt and other instruments that absorb losses if a bank fails and is being shut down.
Total Capital Requirement
When you combine:
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Tier 1 capital
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Tier 2 capital
The bank must reach:
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8% minimum total capital, or
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10.5% including the conservation buffer
A Simple Example
Imagine a bank has:
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$5 million in Tier 1 capital
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$3 million in Tier 2 capital
That’s $8 million total capital.
Now assume the bank’s loans, after adjusting for risk, equal $28.75 million in risk-weighted assets.
To calculate the capital adequacy ratio:
$8 million ÷ $28.75 million = 27.8%
That’s well above the Basel III minimum, meaning the bank is strongly capitalized and better positioned to absorb losses.
Why Basel III Capital Rules Matter
The goal of Basel III isn’t to slow banks down—it’s to make sure they don’t collapse when the economy hits trouble.
Higher capital levels:
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Reduce the chance of bank failures
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Protect depositors and taxpayers
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Make the financial system more stable overall
Banks with stronger capital positions are less likely to need government bailouts during crises.
Basel III and Leverage Limits
Basel III doesn’t rely only on risk-based rules. It also introduced a leverage ratio, which limits how much banks can borrow relative to their capital—regardless of how “safe” assets appear.
This was especially important after the financial crisis, when some banks appeared well capitalized but were actually taking on extreme leverage behind the scenes.
In the U.S., the largest banks—often called “too big to fail”—face even stricter leverage requirements and regular stress tests to ensure they can survive severe economic shocks.
The Three Pillars of Basel III
Basel III rests on three core ideas:
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Minimum capital requirements – ensuring banks hold enough capital
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Supervisory review – giving regulators authority to monitor and intervene
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Market discipline – requiring transparency so investors and the public can assess risk
Together, these pillars aim to create a safer and more accountable banking system.
The Bottom Line
Under Basel III, banks must hold at least 8% capital, and 10.5% when the conservation buffer is included, relative to their risk-weighted assets.
These rules were created to prevent a repeat of the 2008 financial crisis by ensuring banks have enough of their own money at stake. For everyday consumers, that means a more stable banking system, safer deposits, and fewer taxpayer-funded bailouts when the economy hits rough waters.
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