Procyclicality and Macroprudential Policy Framework

1. Procyclicality and Macroprudential Policy Framework Jan Frait Head of Financial Stability

2. Macroprudential Policy Framework

3. What is a macroprudential policy framework? • Following the global financial crisis, on the EU level as well as on the national levels the ways how to establish the additional pillar for financial stability – macroprudential policy framework – is being discussed. • Until the crisis, the concept of macroprudential policy was discussed primarily within the central banking community under the leadership of the Bank for International Settlements (BIS henceforth). The interest of the academic community in the issue was rather limited. • After the crisis, the term “macroprudential” has become a buzzword (Clement, 2010). The establishment of effective macroprudential policy framework has become one of the prime objectives of the G20, EU, IMF and other structures. • In the EU, such a desire has already been reflected in the decision to create the European Systemic Risk Board as the EU-wide authority of macroprudential supervision and by number of iniciatives focusing on defining the EU-wide framework for macroprudential regulation.

4. What is a macroprudential policy framework? • Various issues related to macroprudential considerations have become in the centre of focus of researchers from multinational institutions, central banking community, supervisory authorities and academia. • One of the outcomes of the evolution described above is that the meaning of the multi-facetated concept of macroprudential policy is becoming more and more obscure. The term “macroprudential” is now too embracive and it is often used outside of the scope of its original meaning. • This presentation is going to look at the concept of macroprudential policies from relatively narrow perspective of the original BIS approach (e.g. Borio, 2003, Borio and White, 2004).

5. What is a macroprudential policy framework? • The objective of a macroprudential approach in the BIS tradition is to limit the risk of episodes of financial distress with significant losses in terms of the real output for the economy as a whole. The definition falls within the macroeconomic concept and implicitly involves monetary and fiscal policies (Borio and Shim, 2007, and White, 2009). • In the BIS tradition, the phenomenon of financial market procyclicality (mainly the procyclical behaviour of credit provision) stands centrally (Borio and Lowe, 2001, or Borio, Furnine and Lowe, 2001). • The study of procyclicality has a strong time-series dimension and the gradual build up of vulnerabilties over time has to be the subject of research (Borio, 2009, Brunnermeier et al., 2009, and Borio and Drehmann, 2009). • Macroprudential policies are then defined the set of tools that have a capacity to strenghten the resilience of the financial system as a whole through build up of cushions or potentially reducing its vulnerability via decreasing the amplitude of the financial cycle.

6. What is a macroprudential policy framework? • The other stream is modelling of systemic risk associated with individual institutions. By comparison with canonical models of systemic risk like Diamond and Dybvig (1983) emphasining interlinkages and common exposures among institutions, in the BIS logic, systemic risk arises primarily through common exposures to macroeconomic risk factors across institutions. • The other stream focusing on the cross-section dimension of systemic risk (common exposures among institutions, network risks, infrastructure risks, contagion ...) has been intensively studied by the IMF (see special chapters on systemic risks in the last few Global Financial Stability Reports).

7. What is a macroprudential policy framework? • The ongoing work on macroprudential tools is focusing mostly on the design issues (e.g. Bank of England, 2009, and Drehmann et. al., 2010). • Major progress has been achieved in the design of countercyclical capital buffers. • More focus on the issues of efficiency and feasibility of macroprudential tools should follow. Though there is some certainty that the tools can help to provide the financial sectors with cushions, there is a major uncertainty regarding the potential of the tools to limit the effects of procyclical behaviour in good times. • Should we really believe what the new GFSR says? “The model was also used to investigate the impact of countercyclical capital requirements, andfound that a countercyclical rule linked to credit growth might reduce output variability by around onethirdin the euro area, and by around one-quarter in the United States.“

8. II.Macrofinancial Framework and Monetary Policy?

9. Should monetary policy be part of macroprudential approach? • Until recently a debate „how should central bank react to asset prices“ only, after the crisis the focus broader (credit and leverage) • Central banks automatically has always been taking the asset price developments into account when setting monetary policy: • asset price movements impact on CPI inflation via demand for goods and services used to create assets, • asset price movements also feed into CPI inflation due to the "wealth“ effect, • asset prices also feed through into spending via the effect of improved balance sheets on borrowing capacity of firms and individuals and willingness of lenders to lend. • Normally asset and consumer prices move together, but • sometimes speculative bubbles develop, • bubbles will burst, potential damage may be huge.

10. CBs do not ignore asset prices • Should central banks try to constrain asset price bubbles? • The economists used to be divided into three groups (Bernanke‘s view) • Group A philosophy: • central bank should pay attention to asset markets’ developments, but cannot and should not try to constrain asset price bubbles on their own. • outspoken speaker - Ben Bernanke • Group B approach: • lean-against-the-bubble (BIS economists) • Group C stance: • aggressive bubble-popping

11. Ben Bernanke‘s view • Bernanke (2002) rule for central bank policy regarding asset-market instability: • Use the right tool for the job! • Fed has two sets of responsibilities: • maximum sustainable employment, stable prices, and moderate long-term interest rates, • the stability of the financial system. • Fed has two sets of policy tools: • policy interest rates, • range of powers with respect to financial institutions. • Fed should focus its monetary policy instruments on achieving its macro goals, while using its regulatory, supervisory, and lender-of-last resort powers to help ensure financial stability.

12. Ben Bernanke‘s view • Monetary policy: • to the extent that a stock-market boom causes higher spending on consumer goods and investments, it may indicate future inflationary pressures, policy tightening might be an adequate reaction, • goal of reaction should be to contain the incipient inflation, not the stock-market boom. • Financial sector policies: • central bank should use its regulatory and supervisory powers to reduce the incidence of bubbles and to protect the financial system.

13. Ben Bernanke‘s view • Group B - leaning-against-the-bubble: • not entirely without merit, the uncertainty regarding the effectiveness. • Group C - Aggressive bubble-popping: • risky and dangerous approach, • identical to Federal Reserve Policy in the 1920s - the Fed was trying to prick the stock market bubble but succeeded only to kill the economy.

14. The case against active stance • General arguments against an activist approach: • a central bank cannot reliably identify bubbles in asset prices, • even if a central bank could identify bubbles, monetary policy does not posses appropriate tools for effective use against them, • once a central bank becomes sure that a bubble has emerged, it will probably be too late to act, • pursuing a separate asset price objective could mean having to compromise on normal inflation objective.

15. What Bernanke seemed to ignore? • What if the bubble is emerging without any signs of inflationary pressures? • inflation measured in terms of consumer prices has not always signalled that imbalances in the economy have been building up. • prevailing monetary policy models used to forecast inflation pressures derive demand pressures from current inflation pressures. • A „dilemma“scenario (small open economy case): • higher economic growthÞexcessively optimist expectationsÞnominal appreciation of domestic currencyÞa very low inflation can prevail even under a rapid credit growth and asset price acceleration for rather a long timeÞwhen the open inflation pressures finally appear, it may be too late for monetary policy to react. Note: these points were taken from CNB‘s 2005 presentation.

16. BIS economists disagreed • BIS economists (mainly W. White) argued for a „leaning“ approach to the monetary policy in treating the credit and asset prices boom. • The summary of the approach is best covered by White‘s "post-BIS" paper "Should Monetary Policy "Lean or Clean": • It has been contended by many in the central banking community that monetary policy would not be effective in “leaning” against the upswing of a credit cycle (the boom) but that lower interest rates would be effective in “cleaning” up (the bust) afterwards. • These two propositions (can’t lean, but can clean) are examined and found seriously deficient. In particular, it is contended that monetary policies designed solely to deal with short term problems of insufficient demand could make medium term problems worse by encouraging a buildup of debt that cannot be sustained over time. • .... monetary policy should be more focused on “preemptive tightening” to moderate credit bubbles than on “preemptive easing” to deal with the after effects.

17. How to cope with a „dilemma“ scenario (CNB‘s experience)? • BIS approach (to which the CNB subscribed a lot), untill recently the minority one, was and still is was supportive of leanging-against-the-cycle. • In this approach, if financial stability analyses identify the risk of emerging bubble, central bank may act at an early stage when asset prices are starting to accelerate and before the expansion in credit has become too sharp. • By raising interest rates CB may help to avoid a subsequent collapse in asset prices that could lead to considerably lower output and inflation in the longer term. • At least, central bank policies should be conducted in a way that does not promote build-up of asset market bubbles. • Central banks in small open economies must be ready to use monetary policy steps as a kind of insurance against adverse effects of exchange rate bubbles. • However, there might be a conflict created by the simultaneous impact of monetary policy on both interest rates and exchange rate. The optimal policy therefore may not be available and second-best policies have to be considered.

18. Will BIS approach become a mainstream? • M. Woodford (2010) in recent presentation in Prague (Inflation Targeting and Monetary Policy) summarized growing consensus on the need of leaning: • One needn't be able to predict exactly when crises will occur,only whether the risk of a crisis increases under certaincircumstances. • Nor is the real issue whether assets are overvaluedrather, the degree to which the positions taken by leveragedinvestors pose a risk to financial stability. • Real issue not controlling mis-pricing of assets, but deterringextreme leverage and maturity transformation - even modest changes in short-term rates can affect incentivesfor highly leveraged investing, excessive short-term funding. • Really need to recognize financial stability as independentstabilization objective.

19. Will BIS approach become a mainstream? • M. Woodford (cont.): • ... one can introduce a financial stability objective into a flexible IT framework - financial stability considerations only affect the near-termtransition path to that invariant medium-run infation rate. • The proposed procedure is related to calls for a target for credit growth, but • what matters for the target criterion is leverage of intermediaries, not credit as such, • not solely a leverage target: target criterion still involves price level, output gap, • what matters is marginal crisis risk, rather than leverage as such. • Inflation should be allowed to undershoot normal target in aperiod of elevated marginal crisis risk • but there should be a commitment to make up the insufficientinflation later, so that the long-run price level is unaffected, • credible commitment of this kind would eliminate risk ofdeflationary spiral.

20. III.Procyclicality and Provisioning

21. Procyclicality • Financial system procyclicality means the ability of the financial system to amplify fluctuations of economic activity over the business cycle via procyclicality in financial institutions’ lending and other activities. • The procyclical behaviour of financial markets transmits to the real economy in amplified form through easy funding of expenditures and investments in good times and financial restrictions leading to declining demand in bad times. • Procyclicality have increased over the last few yearsdue to (i) the greater use of leverage in the financial and real sectors, (ii) closer ties between market and funding liquidity e.g. through increased use of collateral in secured financing, (iii) increased contagion effects in integrated markets as well as (iv) the (unintended) effects of some regulations, including accounting standards. (EFC WG Report 2009)

22. To provision or not to provision • Debate about the instruments that might reduce the potential procyclicality of regulation is not a new one. • Borio and Lowe (2001) – To provision or not provision • paper written just prior to the setting and implementation of current regulations, • describes a conflict between the interests of supervisors and accountants, • financial supervisors have tended to emphasise the role that provisions can play in ensuring that banks maintain adequate buffers against future deteriorations in credit quality, • accounting authorities have stressed the importance of provisions in generating fair and objective loan valuations. • The accountants won the battle … but after a few years we seem to be at the start back again.

23. To provision or not to provision, to buffer or not to buffer • After the crisis - to provision or not to provision, to build capital buffers or not to build capital buffers • bank supervisors have always beenmore supportive of liberal general provisioning regimes and reserves than have accountingand securities authorities • this time the supervisors may use the opportunity, but it is not so easy to win a war … • Procyclicality may be caused by broad spectrum of factors going much beyond accounting and capital regulation framework of financial institutions‘ regulation. • The very idea that central bank will do its best by focusing its monetary policy instruments on achieving its macro goals, while using its regulatory, supervisory and lender-of-last resort powers to help ensure financial stability should probably be reconsidered.

24. Procyclicality as a hot issue • ECOFIN roadmap on financial supervision, stability and regulation takes the issue of procyclicality rather seriously: • Valuation and accounting standards: Refinement of the accounting rules in respect of dynamic provisioning • Pro-cyclicality: • Follow-up to the report of the EFC-WG on Pro-cyclicality and the July Ecofin Conclusions Possible measures to address pro-cyclicality of capital requirements in the short term • Identify policy tools to mitigate pro-cyclicality in the financial system and financial regulation, including of capital requirements through counter-cyclical capital buffers in the CRD - dynamic provisioning, proc-cyclicality of CRD. • Similar agenda set also by Financial Stability Board. • Projects set by BCBS and IASB to propose what is required and expected.

25. To provision or not to provision • In general principle, banks should set aside provisions to cover their expected losses while their capital should primarily be used to cover unexpected losses. • There generally exist several provisioning systems differing in either when the provisions are created and entered in the accounts or what event triggers provisioning. • Currently prevailing practice is “specific” provisioning. • specific provisions are fixed against losses on predominantly individually assessed loans and start at the moment an evident event occurs; • specific provisioning is backward looking (i.e. it identifies risk ex post). • General provisions • are set against losses from portfolios of loans and can be forward looking (i.e. they identify credit risk ex ante)

26. To provision or not to provision • The key argument for forward-looking provisioning is the inherent tendency of banks to relax excessively lending standards during economic upturns and tighten them excessively during downturns • the risks are underestimated during upturns leading to credit booms with loans extended with prices set too low, • subsequent downturn leads to re-pricing under the impact of higher default rate, potentially ending in credit crunch. • Forward-looking provisioning should therefore help to ensure correct pricing of expected credit risk emerging at time when the credit is extended.

27. To provision or not to provision • The international accounting standards currently in force (IAS 39) allow banks to provision only for loans for which there is clear evidence of impairment (i.e. backward-looking provisioning). • specific provisions are created and entered in the accounts only after credit risk comes to light (which usually occurs in times of recession), • In the general/dynamic provisioning system provisions are also created when credit risk comes into being (i.e. to a large degree in times of boom) • banks provision against existing loans in each accounting period in accordance with the assumption for expected losses: • at times when actual losses are smaller than assumed a buffer is created which can then be used at times when losses exceed the estimated level… • This looks straighforward, but in practice it is not so.

28. Provisioning in Spain • Spain used „traditional“ provisioning up to 2000: • general provisions (GP) reflected estimate of average expected loss from total loans: • GP = g*ΔL , where L stands for total loans and g for the parameter (between 0.5% and 1%), • while specific provisions (SP) were set in a standard way: • SP= e*ΔM, where M stands for impaired loans and e for the parameter (between 10% and 100%). • total provisions: TP = g*ΔL + e*ΔM. • In 2000, additional compotent was added – statistical provisions: • Total provision (TP) = Specific (SP) + General (GP) + Statistical (StP)

29. Provisioning in Spain • Banks sorted loans to six homogenous categories with different risk coefficient s (defined by supervisor as average specific provision rate over the whole cycle). • StP = Lr – SP, where Lr is a latent risk s*L, where s stands for the coefficient of a historical average specific provisions (between 0% and 1.5% in the standard approach), • SP < Lr (low impairedloans) StP>0 (building up of the statistical fund), • SP > Lr(high impaired loans) StP<0 (depletion of the statistical fund), • balance of the statistical fund: StF = StPt+StFt-1, with a limit: 0≤StF≤3*Lr

30. Provisioning in Spain • System had to be modified with effect from 2005 due to the IRFS – statistical provisions were hidden in newly defined general provisons: Total provision (TP) = Specific (SP) + General (GP) SP: unchanged, GP: • banks must make provisions against the credit growth according to parameter  which is the average ratio of estimated credit losses (“collective assessment for impairment” in a year neutral from a cyclical perspective) and  parameter which is the historical ratio of average specific provision (coefficient s in previous version), • 1st component reflects losses in the past, 2nd reflects specific provisions in the past relative to current ones (dynamic component), • limits for fund set as 0,1% ≤ GF ≤ 1,5% of total loans.

31. Provisioning in Spain • Developments in provisioning funds in Spain after 2000 – developments of provisions‘ components Source: Saurina, J. (2009): The Spanish experience of counter-cyclical regulation. Prague, October 23, 2009.

32. Provisioning in Spain • Spanish authorities considered a new system IFRS compatible (IFSB not). • Fund was set in good times, buffer was created prior to current crisis • NPLs 200% covered at the beginning of 2008 (EU average 60%), • Nevertheless, at the end of 2008 only 100% covered, • not sure whether the fund will suffice ... still better that nothing. • Spanish system viewed as accounting tool – though BdE considers it as part of toolbox for macroprudential supervision. • BdE does not think it distorts accounting statements: • Banks are required to disclose the amount of the dynamic provision, apart from the specific provision. • Thus, users of accounting statements can “undo” the impact of the dynamic provision on the P&L.

33. Provisioning in Spain • Spanish system was rather simple – a kind of pre-dynamic provisioning: • not optimal, just one of potential solutions, • not sure whether it really restricts excessive lending, • can hardly be adopted in current recessionary conditions, • unilateral attempts to do so might do more harm than gain – see Brunnermeier, M. et al. (2009), • proposal by Commissionto use it via CRD supported neither by industry nor by supervisors (including the CNB).

34. Do the Czech banks provision procyclically? • There is a negative relationship between GDP growth and the ratio of loan loss provisions to total loans in the Czech Republic for the period 1998–2008. • Does it reflect procyclical behaviour? • If yes, how strong are the non-procyclical features of banks‘ behaviour? • For results see Frait and Komárková (2009)

35. Do the Czech banks provision procyclically? • Variables: • macroeconomic: the growth rate of real GDP (ΔlnGDP), • the unemployment gap (UNEMPL_gap); • bank-specific: the ratio of loan loss provisions to average total assets (LLP/TA), loan growth (ΔlnLOANS), the ratio of total loans to TA (LOANS/TA), pre-tax earnings (EARN), the ratio of equity capital to TA; • other: „t“ denotes time and „i“ the individual banks, TA stands for the average total assets for the two periods (0.5(TAt+TAt-1)).

36. Do the Czech banks provision procyclically? • If banks behave procyclically, the rate of economic growth will be negatively correlated with provisioning, unemployment rate gap positively, loans growth and the ratio of total loans to total assets positively if banks behave prudentially, pre-tax profitpositively, capital ratio more likely negatively.

37. Do the Czech banks provision procyclically? • Conclusions: • The negative GDP growth and positive unemployment rate gap suggest that provisioning is significantly procyclical and lacks to a large extent forward-looking assessment of cycle-related risk; • …however • The procyclicality is being partly reduced: • (i) positive and relative high coefficient of the pre-tax profit = the income smoothing or tax optimization, • (ii) positive coefficient of loans to total assets = prudential behaviour confirmed; • … but banks set aside fewer provisions to cover their expected losses when their capital buffer is larger (negative capital/TA coeff.).

38. IV.Proposals for taming procyclicality

39. Existing proposals for taming procyclicality • Through-the-cycle expected loss provisioning (TELP) – EU Commission consultation to further changes in CRD from July 2009: • Based on through-the-cycle expected loss – forward looking estimation of losses that should be covered by TELP. • TELP designed in line with Spanish approach – baseline method uses both α and β parameters, more simple method considers parameter β only. • Prudential measure of a „corrective kind“ which nevertheless has impact on the accounting. • Proposal does not address the issue of consistency between IFRS and CRD. • TELP potentially in conflict with regulatory concept of expected loss in Basel II. • IRB institutions (only) apply models to set expected losses and their coverage by provisions is tested (if provisions not sufficient, difference deducted from regulatory capital).

40. Existing proposals for taming procyclicality • Expected loss approach (IASB, June 2009) • The expected cash flow approach - currently being considered as a part of IASB project on replacing IAS 39 Financial Instruments Measurement and Recognition. • A major deviation from incurred loss approach - no trigger for an impairment test required • it should reflect better the economic reality of banks’ lending activities than the incurred loss approach in that it requires an earlier recognition of expected credit losses, • it should help to avoid ‘incurred but not reported losses’. • The present value of the expected future cash flows is measured using an initial internal rate of return calculated on the basis of cash flows actually expected at inception (taking into account expected credit losses), and not on the basis of contractually agreed cash flows.

41. Existing proposals for taming procyclicality • Expected loss approach (IASB, June 2009) cont. • Initial internal rate of return will thus be lower than the contractual rate, with the difference representing the risk premium charged to the borrower in order to cover the statistically foreseeable risk of non-recovery. • Difference between cash flows received that represent contractual interest and interest recognised as revenues on the basis of the (lower) internal rate of return would be recognised in the balance sheet as a credit expected loss provision. • Subsequent or additional impairment loss is recognised through continuous re-estimation of credit loss expectations. Reversal of impairment loss is recognised in profit or loss when there is a favourable change in credit loss expectations. • Would bring subjectivity, number of complex issues, transparency issues. • Spanish approach and economic cycle reserve can serve as complementary tools to it.

42. Existing proposals for taming procyclicality • Economic cycle reserve (ECR) – UK Turner review • An additional non-distributable reserve which would set aside profit in good years to anticipate losses likely to arise in future. • A formula driven method would simple and non-discretionary similarly to Spanish system: • a buffer of the order of magnitude of 2 – 3 % of RWAs at the peak of the cycle, • reserve could vary according to some predetermined metric such as the growth of the balance sheet or estimates of average through-the-cycle loan losses. • A discretionary method would be entity-specific, tailored to the peculiarities of each bank’s portfolios.

43. Existing proposals for taming procyclicality • Economic cycle reserve (ECR) – UK Turner review cont. • The approach has a macro-prudential defensive focus and is meant to be accounting neutral • it is to be shown only as a movement on the balance sheet, rather than on the P&L (is intended to be built and drawn by appropriation of retained earnings), • but there are very strong arguments that it should also appear somewhere on the P&L, • allowing bottom line profit and earnings per share (EPS) to be calculated both before and afterits effect, and thus providing two measures of profitability, the ‘traditional’ accounting figureand a second figure struck after economic cycle reserving. • Counter-cyclical capital buffers (under Basel III) – now at the most advanced stage due to its attractiveness to the regulators and supervisors.

44. V.Counter-cyclical capital buffers

45. Capital buffers:nothing new • Borio and Lowe (2001)revisited • One possibility … is a clearer treatment of the relationship between provisions and regulatory capital … • to exclude general provisions from capital and to set provisions so that they cover an estimate of the net embedded loss in a bank’s loan portfolio, • capital could then be calibrated with respect to the variability in those losses (their “unexpected” component). (p. 46) • Another approach … supervisors could supplement capital requirements with a prudential provisioning requirement … • instead of having the annual statistical provisioning charge deducted from a bank’s profit and loss statement, have it added to the bank’s regulatory capital requirement for unexpected losses. (p. 48)

46. Capital buffers:nothing new • Procyclicality of Basel II was widely debated prior its implementation. • There was a clear understanding that risk-sensitive regulatory capital requirements tend to rise more in recessions and grow less during expansions, laying the ground for potentially pro-cyclical effects. • The authors of the framework therefore pretended that they included some mitigating factors to dampen the potential pro-cyclical effect of Basel II's increased risk-sensitivity. • Although improved risk management was one of the arguments for the introduction of Basel II, it now appears that neither regulatory capital nor economic capital has been set adequately to capture actual risk, particularly the risk contained in the trading book.

47. Capital buffers:nothing new • High (perceived) costs of scraping Basel II down have been reflected in the desire of regulators/supervisors to continue relying on Basel II framework in dealing with procyclicality. • First, they hoped, after the current crisis, micropolicies might become easier for implementation including „theoretical“ tools within current Basel II-Pillar 2: • Internal Capital Adequacy Assessment Process, Supervisory Review and Evaluation Process • Stress testing with scenarios and methodology from supervisors • Backward testing of PDs and LGDs, downturn LGDs, conservative margins, tests of adequacy of provisions ... • Second, they struggled to add some procyclicality-mitigating factors into the concept.

48. CEBS proposal • CEBS (CEBS, 2009) proposed practical tools for supervisors to assess under Pillar 2 the capital buffers that banks have to maintain under the Basel II/CRD framework (focusing on procyclicality of banking book of IRB banks). • CEBS was considering the use of mechanisms that adjust probabilities of default (PDs) estimated by banks, in order to incorporate recessionary conditions. • Current PD: the long-term average of the default rates (either at the grade or portfolio level). • Downturn PD: the highest PD over a predetermined time-span. • The scaling factor is: SF = PD_downturn / PD_current (close to 1 in a recession and higher than 1 in expansionary phases). • The size of the buffer decreases in recession and increases in an upswing. • CEBS says proposal might easily be adapted in a Pillar 1 context, but ...

49. Countercyclical capital buffers • BCBS‘s Countercyclical Capital Buffer proposal (2nd stage, issued for comments in September 2010) • The CCB proposal is designed to ensure that banking sector capital requirements take account of the macro-financial environment in which banks operate. • The primary aim is to use a buffer of capital to achieve the macroprudential goal of protecting the banking sector from periods of excess credit growth that have often been associated with the build up of system-wide risk. • Protecting the banking sector in this context is not simply ensuring that individual banks remain solvent through a period of stress. Rather, the aim is to ensure that the banks in aggregate has the capital on hand to maintain the flow of credit in the economy without its solvency being questioned, when the financial system experiences stress after a period of excess credit growth. • This focus on excess aggregate credit growth means that jurisdictions are likely to only need to deploy the buffer on an infrequent basis, perhaps as infrequently as once every 10 to 20 years.

50. Countercyclical capital buffers • The starting point is Basel III new regulatory capitalization minimums: • New common equity ratio (Core Tier1, CT1) of 7%, split between a 4.5% minimum requirement and a conservation buffer of 2.5%. • A countercyclical buffer of up to 2.5% of common equity, implemented according to national circumstance. • A supplementary, non-risk-based leverage ratio, to be tested at 3%. • Systemically important banks to carry loss-absorbing capacity “beyond the standards announced”. • The CCB is thus presented as an add-on to the capital conservation buffer, effectively stretching the size of the rangein which restrictions on distributions of profits are applied. • To allow banks time to adjust to a buffer level that exceeds the fixed capital conservation range, they would be given 12 months to get their capital levels above the top of the extended range, before restrictions on distributions are imposed.