With a little help from my friends: counter-cyclical capital buffers during the Covid-19 crisis

Dennis Reinhardt and Carlos van Hombeeck

Have post-crisis reforms of banking regulation made banks and lending more resilient to the shock from Covid-19 and if so by how much? This blog takes one specific example – countercyclical capital buffers (CCyBs) – and shows that policy makers in a range of countries were able to quickly release these capital requirements, enabling banks to use the cumulated buffers. This released capital may in turn potentially help banks to support lending. And it will likely benefit lending in the country releasing requirements on buffers as well as banks’ lending to other countries, leading to potential positive international spillovers (see e.g. discussion of spillovers due to macroprudential policies by the ECB and others).

These expected outcomes are to some extent because of the way CCyBs have been implemented. Due to reciprocity agreements, foreign banks with exposures to countries with positive CCyB rates are required to hold capital against such exposures. So cutting requirements on CCyB may release capital for both domestically-regulated banks and foreign banks.

And this is what happened following the onset of the Covid-19 crisis, when multiple jurisdictions announced cuts in CCyB rates, effective in 2020 Q1 or Q2 (Figure 1).

Chart 1: Effective CCyB rates before and after the Covid-19 Shock (%)

Sources: ESRB, HKMA, BIS, national authorities’ websites. Listing countries which had a non-zero pending  or effective rate at some point since 2015 Q1. The blue dots refer to pending increases which were announced before the Covid-19 episode but did (and will) not become effective. Information up to 2020 Q2.

Figure 2 shows the evolution of effective CCyB rates from an UK viewpoint. It calculates the UK average (weighted by UK banks’ country exposures) of effective foreign CCyB rates implemented around the globe. Capital buffers due to foreign CCyB requirements have gradually risen from 2016 onwards to reach a peak in 2019. The response to Covid-19 implied a sharp drop in 2020 Q1 capital buffers requirements and further planned reductions in 2020 Q2.

Figure 2: UK exposure-weighted foreign effective CCyB rate (%)

Sources: BIS Consolidated Banking statistics, ESRB (based on national authorities) and HKMA. Foreign CCyB’s weighted by UK-owned banks consolidated exposures to the non-bank non-financial sector in foreign countries.

Before the Covid-19 shock, as CCyB rates went up, banks around the globe were required to increase their capital holdings once they had relevant exposures. Relevant here are exposures to their own jurisdictions or to foreign jurisdictions due to exposures via direct cross-border lending or via their foreign affiliates.

Using data on CCyBs and the BIS consolidated banking statistics allows us to obtain a rough estimate of the required capital due to the implementation of domestic and foreign CCyBs for all BIS reporting banking systems taken together (Figure 3). It also shows required capital holdings due to foreign CCyBs.

Banks around the world held around $73bn of capital due to CCyBs effective in 2019Q4. Highlighting the international dimension, almost half ($32bn) was due to banks’ foreign exposures.

The required capital released by 2020 Q2 already amounts to $64bn, with $24bn of this reduction due to foreign exposures. Overall, we estimate – making assumptions on target capital ratios and risk weights for new lending – that this may support up to $530bn in new lending to businesses globally. These numbers are likely to be an underestimate given some countries (including the UK) announced higher future rates than already effectively implemented and banks are likely to have already raised capital in preparation.

Figure 3: Global banks’ required capital due to CCyBs ($bn)

Sources: ESRB, HKMA, BIS consolidated banking statistics and authors’ calculations.

The Bank of England FPC’s decision to lower the CCyB rate has contributed to the reduction in required capital holdings for foreign banks (this is included in the red line in Figure 3). This should help to support banks’ lending locally and abroad (including the UK). Specifically, we estimate based on the same data used in Figure 3 that the cut in the UK’s CCyB rate might free up around $9bn in capital for foreign banks with exposures to the UK.

Taken together the findings suggest that the CCyB framework introduced after the Global Financial crisis was an effective tool to respond to the Covid-19 shock. It allowed countries to release buffers and support bank lending in a time of high uncertainty.

The almost simultaneous release of capital buffers by many countries created positive international spillovers. While countries are committed to reciprocate the CCyB, the response to most other macroprudential policies is voluntary (see e.g. this discussion of reciprocity). As shown by the experience of the CCyB, given interlinkages between financial systems, policy coordination can amplify the impact of policy measures, which can be particularly important in the face of global shocks.

Dennis Reinhard and Carlos van Hombeeck work in the Bank’s International Directorate.

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