Countercyclical capital buffer: more capital to counter crises

Trouble in the financial system can quickly become a real and immediate problem for any of us – look no further than the pace with which the financial crisis spilled over into the real economy between 2007 and 2009, forcing many businesses to introduce short-time working and leaving a trail of unemployment in its wake. In an effort to contain the risk of global financial crises, the Basel Committee on Banking Supervision published a set of new capital and liquidity standards for credit institutions in 2010 (otherwise known as the Basel III regime). These standards subject bank lending to particularly intense scrutiny, which is hardly surprising given that excessive real estate lending in the United States was one of the factors which sparked the financial crisis in the first place.

Banks more resilient to losses

One of the core components of the Basel III regime – the countercyclical capital buffer – is all set to be introduced by Germany's banking supervisors on 1 January 2016. Responsibility for setting and publishing the domestic buffer rate in Germany lies with the Federal Financial Supervisory Authority (BaFin), while the Bundesbank will deliver the analytical groundwork for setting the buffer at an appropriate rate. The Bundesbank has now disclosed its methodological approach in a paper entitled "The countercyclical capital buffer in Germany".

Supervisors can activate the countercyclical buffer contrary to developments in bank lending. If they consider that excessive bank lending is being channelled into the private sector, they can force banks to hold more capital. Losses that hit banks further down the road are then easier to absorb thanks to this additional capital cushion. The stricter capital adequacy requirement can also encourage banks not to step up their lending still further. If, on the other hand, supervisors see aggregate lending returning to more normal patterns, they can gradually release the capital buffer.

How Germany calculates the capital buffer

A key input in setting the capital buffer is the credit-to-GDP gap, as the paper explains. This indicator shows whether lending is growing more quickly than a given country's economic activity by historical standards. Thus, a positive gap can point to excessive credit growth. Supervisors then use the credit-to-GDP gap to quantify a buffer guide. But for the Bundesbank, this metric alone does not deliver sufficient information on how much additional capital should actually be set aside. A single indicator can very easily deliver the wrong signal, the authors caution, which is why further indicators – for private sector indebtedness and developments in the real estate market, say – are also fed into the buffer rate calculation. Quantitative and qualitative market information as well as insights from stress tests are also added to produce a comprehensive economic analysis. Ultimately, then, the decision on setting the capital buffer rate is based on a combination of the buffer guide and discretionary elements.

The countercyclical capital buffer has already been put into practice by banking supervisors in Norway and Sweden, where a buffer requirement became mandatory for the first time in the previous quarter. The authors concede that it will take some time before the effects of these measures can be assessed, but they note that analyses of instruments with a comparable effect already suggest that this new macroprudential instrument can contribute effectively to strengthening the resilience of banks in times of crisis.