To calculate the equity in a bank model, you first have to start with Risk Weighted Assets. In this example, we've got a bank and it's made a number of loans to customers, including overdrafts, credit cards, mortgages, et cetera. When all added up, that comes to 27,482 and that's your total lending book before risk weighting.

The regulator looks at that 27,482 and says some of those items are riskless. Maybe you've lent to the government. That's completely riskless, but some of the other items do carry risk and they might go down in value. If they go down in value, you're going to make some losses and the regulator says, we want you to put aside some equity in case you do make those losses. So, the regulator applies a risk weighting and calculates a figure called your Risk Weighted Assets. In this example, your 27,482 are deemed to have Risk Weighted Assets of 18,207, i.e. 66% of your loan book.

So, the regulator says that 18,207, we think there's risk on those assets. We think they could make losses. Therefore, we want you to put some equity aside and that's called your Common Equity Tier 1.

In this example, 13.3% of your Risk Weighted Assets is set aside. So, that's your target Common Equity Tier 1 Ratio. That plus gives you a Common Equity Tier 1 of 2,420.

So, here we've got your Common Equity Tier 1, 2,420, but that's not necessarily the level of equity we'll see in the bank's balance sheet. Instead, in this example, we see common stock in the bank's balance sheet of 2,812. That's higher than the Common Equity Tier 1. Why is this the case? Well, if you think your common stock or equity in the balance sheet, that's also your net assets and the regulator says we don't like some of your net assets. Some of them don't hold any value. In this example, we've got intangible assets, deferred tax assets and defined benefit pension fund assets. These assets are deemed to hold no value or they're not accessible in a liquidation. So, if they don't hold any value, but you do have them on your balance sheet, that means you need a higher equity or common stock level than has been given to you from the Common Equity Tier 1 figure. So, Common Equity Tier 1 of 2,420. We then add on these adjustments to get to the common stock of 2,812, and that is your balance sheet figure.