Definition:

Common Equity Tier 1 (CET1) Ratio is a key measure of a bank's financial strength, representing the core equity capital compared to its total risk-weighted assets. It is used to assess a bank's ability to withstand financial distress and absorb losses.

Formula:

CET1 Ratio = (Common Equity Tier 1 Capital) / (Risk-Weighted Assets)

How to use the metric:

The CET1 Ratio is used by regulators and investors to evaluate a bank's capital adequacy. A higher CET1 Ratio indicates a stronger capital position, suggesting the bank is better equipped to handle economic downturns and financial shocks.

Limitations:

The CET1 Ratio may not fully capture a bank's risk exposure, as it relies on risk-weighted assets, which can be subject to manipulation or misestimation. Additionally, it does not account for off-balance-sheet exposures or other financial risks.

Applies to:

The CET1 Ratio is primarily applicable to the banking and financial services industry, where regulatory capital requirements are critical for maintaining financial stability.

Doesn't apply to:

The CET1 Ratio does not apply to non-financial industries, such as manufacturing or retail, as these sectors do not have the same regulatory capital requirements or risk-weighted asset considerations.

Summary:

The Common Equity Tier 1 (CET1) Ratio is a crucial metric for assessing a bank's capital strength and ability to absorb losses. While it provides valuable insights into a bank's financial health, it has limitations in capturing all risk exposures and is specific to the banking industry.