Rosanna Costa: Macroprudential policy and the countercyclical
buffer
Opening remarks by Ms Rosanna Costa, Governor of the Central Bank of Chile, at the
workshop "Macroprudential policy and the CCyB", Santiago de Chile, 16 December
2022.
* * *
Good morning. I am pleased to welcome everyone to today's workshop on
macroprudential policy and the countercyclical buffer. Thank you for being here,
participating and lending your attention to this important topic. We have gathered a
great lineup of speakers, who will address a range of timely and important issues on the
matter.
In the aftermath of the global financial crisis, banking regulators agreed on an updated
set of banking regulations aimed at improving the resilience of the global financial
system, highlighting among them the role of new buffers intended to help banks build
sufficient resources in normal times so that in a period of stress they can absorb losses
and avoid a disruptive reduction of lending. The buffers have two objectives (Basel
Committee, 2020b): first, to ensure that banks absorb losses in times of stress without
breaching their minimum requirements; and second, to keep credit flowing to the real
economy in a downturn by lending to creditworthy businesses and households.
In December 2010, the Basel Committee on Banking Supervision (BCBS) published the
Basel III framework with the global regulatory standards on bank capital adequacy and
liquidity, including a countercyclical capital buffer (CCyB). Its primary objective would be
to protect the banking sector from periods of excessive aggregate credit growth, often
associated with the accumulation of systemic risk. In general terms, the CCyB would be
activated and increased by authorities whenever aggregate credit growth was judged to
be excessive and associated with a build-up of system-wide risk. The buffer can be
reduced during a downturn to help ensure that banks maintain the flow of credit in the
economy.
Considering that this is a new macroprudential tool, the evidence of implementations is
still limited. Notwithstanding that, the number of countries that have developed a policy
framework is increasing and the number of jurisdictions that have set a positive buffer
level increased significantly over recent years. Until now, around forty countries have
been using the CCyB, with heterogeneous effects depending on their local conditions
and vulnerabilities. Furthermore, during the Covid-19 crisis, many countries released
their countercyclical capital buffers, marking the first time that the CCyB was used
widely in a downturn. Among them we can mention France, Germany, Sweden,
Switzerland and United Kingdom (BIS, October 2022). These countries lowered the
CCyB either completely or partially.
Recent reports from the Basel Committee are also focused on providing empirical
evidence regarding buffer usability and cyclicality of the framework. So far, the evidence
gathered suggests that although the countercyclical capital buffer may be less effective
to contain the build- up phase of the credit cycle. However, it may help to strengthen
banks' solvency and mitigate the risk that banks' lending standards amplify an
economic downturn as well as all the spillovers implied.
Several potential reasons have been put forward for the reluctance of banks to use their
buffers. Among them, the literature highlights: the stigma of the market, the uncertainty
around possible future credit losses and the uncertainty around supervisory
expectations regarding the restoration of any reserve provision (Hernandez de Cos,
2021b).
In the case of Chile, this new macroprudential took was incorporated in the latest reform
to the General Banking Law approved in 2018.
Within the framework of the implementation of Basel III in Chile, the BCCh was
empowered to determine the countercyclical capital requirement to banks. The General
Banking Law gives the Central Bank of Chile the power to determine the activation or
deactivation of the countercyclical capital requirement. Once the activation decision has
been made, the Central Bank must set its level and deadline for compliance, after a
favorable report from the Financial Market Commission. As recommended by the Basel
Committee, this requirement can be established between 0 and 2.5% of risk-weighted
assets and must be paid entirely with core capital (CET 1), above the minimum capital
requirements established by the General Banking Law.
In this context, in 2021 the Board of the Central Bank of Chile published a policy
framework to implement this Capital Requirement as a macroprudential tool to preserve
the stability of the financial system as a whole, rather than the solvency of a particular
bank. In this sense, it reduces the impact of risk materialization on the banking sector
and, therefore, on financial stability, avoiding restricting essential services, such as the
supply of credit, and protecting the overall economy.
The Countercyclical Capital Requirement should be activated or increased before an
episode of financial stress materializes, i.e., during periods in which it is assessed that
vulnerabilities are incubating in the banking sector that generate systemic impact. This
also prevents and mitigates abrupt reductions in credit in the future, thus mitigating the
potential amplification of shocks to the rest of the economy.
The activation of the Countercyclical Capital Requirement depends on an overall
assessment of the outlook for financial stability and not on a specific indicator. All in all,
it is a macroprudential instrument that must consider its impact on the financial system,
recognizing differentiated spaces for other micro prudential actions and measures.
The standardized background set defined by the Central Bank to decide the activation
of the Countercyclical Capital Requirement is divided into four steps that feed into each
other. First, the regulatory context which is a summary of new regulation or international
standards that need to be taken into consideration in the setting of the CCyB. Second,
an exhaustive analysis of the current stage of the credit and its drivers. Third, a
heatmap reviewing multiple variables that includes indicators for vulnerabilities, risks,
and financial and macroeconomic conditions. Fourth, macro financial models that are
used to create a medium- and long-term macro financial outlook on future trends that
contribute to the financial policy decision-making.
In addition, the modelling part plays an important role in the stress exercises, which
measure the vulnerability of the system and helps guide the activation and calibration of
the buffer. Also, the Central Bank of Chile counts on complementary models that have
been developed to discuss potential macroeconomic effects and support trade-off
analysis. As stated in the policy framework, the activation and release of the CCyB
requires expert judgment from the central bank's board. Also, interaction with the
Financial Market Commission plays a crucial role in the decision process.
Looking forward, our policy research agenda should continue looking at the interaction
of different policies with the CCyB and its macroeconomic impacts, such as the
interaction between financial and monetary policies; the relation with other prudential
policies and/or other buffers and the evaluation of the impacts of a neutral level higher
than zero for the level of the CCyB in "normal times".
The first official Financial Policy Meeting, formally communicated to the market, took
place in May 2022 and the most recent one occurred last November. On both
occasions, the Board unanimously decided not to activate the CCyB. It was considered
that, despite vulnerabilities focused on some sectors and a more complex international
environment, the systemic risk analysis shows that banks have sufficient buffers to
withstand severe stress scenarios.
Notwithstanding the above, we believe that since this is a novel macroprudential tool,
both in Chile and at a global level, there is a need to continue the process of deepening
our understanding of this buffer and its effects on different economic and financial
variables, its interaction with monetary policy, on the one hand, as well as coordination
and interaction with micro prudential tools and supervision, on the other. In this sense,
learning from the experience of other countries, from relevant local and international
experts and stakeholders can make a significant contribution to this discussion, which is
precisely the purpose of this workshop.
The speakers and panelists will be exploring a wide range of topics: (i) The UK
experience using stress tests to support countercyclical buffer decisions; (ii) the role of
macroprudential policy in the recent Covid-19 pandemic; (iii) the effect of capital-based
regulation on banks' pricing policies in other emergent countries, like the Czech
Republic; and (iv) how to assess the impact of the macroprudential policies in
quantitatively rich macroeconomic models. The workshop will be followed by an
invitation-only session with discussions with local and international stakeholders and
private sector authorities.
Let me finish by thanking you all for taking the time to join us today in this workshop.
This tool is crucial to accomplish our mandate of reducing systemic risk in the financial
sector. Even though we have made substantial progress implementing the framework
around this prudential tool, there is more work to be done. This workshop will help us
learn from other practitioners' experiences who have already tackled some of the issues
we are due to solve or are in the process of doing so. I wish you all a very productive
rest of the day discussing about these issues.
Thank you.