Regulatory capital vs IFRS equity

A bank's capital ratio is one of its most watched numbers, and it is built from the accounts. But regulators do not accept IFRS equity as it stands. This guide walks through the bridge from IFRS equity to CET1, explains each adjustment, and shows how accounting decisions, from ECL to intangibles, feed through to capital.

By Mirza Fahad Baig, Chartered Accountant. Reviewed by Hamza Fida, Chartered Accountant. 3 minute read.

Short answer

Regulatory capital vs IFRS equity: banks' common equity tier 1 (CET1) capital starts from equity in the IFRS balance sheet but makes a series of prudential adjustments. Under the Basel III framework as implemented in most jurisdictions, goodwill and other intangible assets, certain deferred tax assets, foreseeable dividends and the cash flow hedge reserve are removed, and further deductions reflect prudent valuation and any shortfall of provisions against expected losses. In this guide's example, IFRS equity of 10,000 becomes CET1 of 7,200, a ratio of 14.4% on risk-weighted assets of 50,000.

At a glance

Starting point
IFRS shareholders' equity
Main deductions
Goodwill, intangibles, some deferred tax
Removed
Cash flow hedge reserve, own credit gains
Also deducted
Foreseeable dividends, prudent valuation
Ratio
CET1 / risk-weighted assets
Framework
Basel III, as implemented locally
Regulatory capital vs IFRS equityStarting point: IFRS shareholders' equity; Main deductions: Goodwill, intangibles, some deferred tax; Removed: Cash flow hedge reserve, own credit gains; Also deducted: Foreseeable dividends, prudent valuation; Ratio: CET1 / risk-weighted assets; Framework: Basel III, as implemented locally.KEY FACTS AT A GLANCERegulatory capital vs IFRS equityStarting pointIFRS shareholders' equityMain deductionsGoodwill, intangibles,some deferred taxRemovedCash flow hedge reserve,own credit gainsAlso deductedForeseeable dividends,prudent valuationRatioCET1 / risk-weightedassetsFrameworkBasel III, as implementedlocallyTax BakersRegulatory capital vs IFRS equityStarting point: IFRS shareholders' equity; Main deductions: Goodwill, intangibles, some deferred tax; Removed: Cash flow hedge reserve, own credit gains; Also deducted: Foreseeable dividends, prudent valuation; Ratio: CET1 / risk-weighted assets; Framework: Basel III, as implemented locally.KEY FACTS AT A GLANCERegulatory capital vs IFRS equityStarting pointIFRS shareholders' equityMain deductionsGoodwill, intangibles, some deferred taxRemovedCash flow hedge reserve, own credit gainsAlso deductedForeseeable dividends, prudent valuationRatioCET1 / risk-weighted assetsFrameworkBasel III, as implemented locallyTax Bakers
Key facts at a glance, as set out in this guide.

Regulatory capital vs IFRS equity: an example bridge to CET1

From IFRS equity to CET1 (CU million)From IFRS equity to CET1 (CU million)10,000IFRS equity-800AT1 inequity-1,200Goodwill andintangibles-300Deferredtax-400Dividends-100Other7,200CET1
Prudential adjustments remove items that cannot absorb losses.
CU millionAmount
Total equity under IFRS10,000
Additional tier 1 instruments in equity-800
Goodwill and other intangible assets-1,200
Deferred tax assets relying on future profits-300
Cash flow hedge reserve+100
Foreseeable dividends-400
Prudent valuation adjustment-50
Expected loss shortfall-150
CET1 capital7,200
Risk-weighted assets50,000
CET1 ratio14.4%

The figures are illustrative. Exact deductions, thresholds and transitional rules depend on the jurisdiction's implementation of Basel III, and some deductions apply only above thresholds linked to CET1.

Why do regulators adjust IFRS equity?

Capital must be able to absorb losses while the bank is a going concern. Goodwill and intangible assets have little value in a crisis, deferred tax assets that depend on future profits may never be realised, and dividends already planned will leave the bank. The cash flow hedge reserve is removed because it relates to hedged cash flows not yet recognised, and gains on the bank's own liabilities from its own falling creditworthiness are removed because they would increase capital as the bank weakens.

Why are additional tier 1 instruments deducted from CET1?

Perpetual bonds whose coupons are fully discretionary are often classified as equity under IAS 32, because the bank has no obligation to pay. They count as additional tier 1 capital, not common equity, so they are taken out of the CET1 calculation and counted in the next layer.

How does ECL affect capital?

Higher loss allowances reduce IFRS equity, and so CET1. Banks using internal ratings models compare their accounting provisions with regulatory expected losses; a shortfall is deducted from CET1, while an excess may be added to tier 2 capital within limits. When IFRS 9 increased allowances in 2018, many regulators allowed the effect on capital to be phased in over several years. See ECL stages and bank accounting.

The expected loss shortfall works like a top-up: if a bank's internal models say losses on performing loans should be 900 but its accounting provisions are 750, the 150 difference is deducted from CET1.

Which accounting decisions affect capital most?

  • Capitalising software: software intangibles are generally deducted from CET1, though some regimes allow prudently valued software a lighter treatment.
  • Deferred tax recognition: deferred tax assets from tax losses are deducted, so recognising them adds nothing to capital.
  • Fair value measurement: prudent valuation adjustments deduct part of the uncertainty in Level 3 valuations.
  • Hedge accounting: cash flow hedge gains and losses are neutralised for capital.

What is the leverage ratio?

A simpler backstop to risk-based capital ratios, introduced because risk weights can understate risk: tier 1 capital divided by a measure of total exposure that includes on-balance sheet assets and off-balance sheet items. Because it starts from accounting balances, gross presentation of derivatives and repos under IFRS increases the exposure measure, although regulatory rules adjust for some netting.

Where is the bridge disclosed?

Banks publish a reconciliation of IFRS equity to regulatory capital in their regulatory disclosures, often called Pillar 3 reports, and summarise capital ratios in the annual report. IAS 1, and from 2027 IFRS 18 with IAS 8, require disclosure of the bank's objectives, policies and processes for managing capital. See bank hedge accounting and deferred tax assets.

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Questions people ask

How does regulatory capital differ from IFRS equity?

CET1 starts from IFRS equity but removes items such as goodwill, intangibles, certain deferred tax assets, foreseeable dividends and the cash flow hedge reserve.

Why are intangible assets deducted from bank capital?

Because they are unlikely to have value that can absorb losses in a crisis.

How does ECL affect a bank's CET1?

Higher allowances reduce equity and therefore CET1; banks using internal models also deduct any shortfall of provisions against regulatory expected losses.

Are AT1 bonds equity under IFRS?

Often yes, if coupons are fully discretionary, but they count as additional tier 1, not CET1, capital.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IFRS 9 Financial Instruments
  2. Bank for International Settlements: Basel III framework

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

BankingBank accounting: the key IFRS issuesECLECL stages 1, 2 and 3 explainedBankingHedge accounting for banks' interest rate risk

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This guide is general information. It is not tax or legal advice for your situation.