Bank Analysis School eBook
Appendix B: New Capital Rule / Capital Conservation Buffer Background
The New Capital Rule (fully implemented in 2019) was enacted to strengthen the capital requirements for banks. It introduced the Capital Conservation Buffer, which is an additional 2.5% of risk-weighted assets that banks must hold above the PCA minimum capital thresholds 1 to avoid limitations on dividends and discretionary payments to executives. The buffer applies to the three risk-based capital ratios: Common Equity Tier 1 (CET1) Capital Ratio, Tier 1 Capital Ratio, and the Total Capital Ratio. Ramifications of falling below the capital conservation buffer The maximum payout ratio is the portion of the bank’s earnings that can be used for distributions such as dividends and discretionary bonus payments to executive officers. If a bank's capital falls below the required buffer, it must retain a larger portion of its earnings to build its capital back up. As shown below, the extent of payout restrictions depends on how far the bank’s capital falls below the capital conservation buffer. The lower the buffer, the stricter the limitations on distributions.
Capital Conservation Buffer (% of Risk-Weighted Assets)
Maximum Payout
≥ 2.500 > 1.875 > 1.250 > 0.625 ≤ 0.625
No limitation
60% 40% 20%
0%
Risk-based capital ratios under the New Capital Rule
Full Buffer (Minimum + 2.5%)
Ratio
Minimum 1
Common Equity Tier 1 Capital Ratio
4.5% 6.0% 8.0%
7.0% 8.5%
Tier 1 Capital Ratio Total Capital Ratio
10.5%
Interaction with PCA The New Capital Rule is distinct from the PCA framework. However, the minimum capital requirement for calculating the Capital Conservation Buffer align with the PCA’s Adequately Capitalized thresholds. When fully applied, the buffer increases capital requirements to 50 basis points above the Well Capitalized thresholds for each risk-based capital ratio.
1 Minimum capital = Adequately Capitalized thresholds under the PCA standards.
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