Capital Conservation Buffer

Basel III set the buffer at 2.5% of risk-weighted assets, held in common equity, on top of the minimum. In good times a bank is expected to hold it in full. In bad times the buffer is meant to be used to absorb losses, without the bank breaching its legal minimum. The penalty for using it is not a breach but a sliding scale of payout restrictions: the deeper into the buffer, the less profit a bank may distribute. This conserves capital when it is most needed. It differs from the countercyclical buffer, which changes with the credit cycle, and from firm-specific add-ons set after supervisory review. Investors watch for any bank that dips into the buffer, which is why many hold a margin above it and treat the buffered level as the real floor.

After loan losses, a bank's common equity ratio falls to 6%. The bare minimum is 4.5% and the full requirement with the 2.5% buffer is 7%, so the bank is inside the buffer zone. It has not breached the minimum, but it must now retain most of its earnings. The board cancels the planned dividend and suspends staff bonuses until the ratio is back above the full requirement.