setting counter-cyclical capital buffers in converging economies jan frait
TRANSCRIPT
Setting counter-cyclical capital buffers in converging economies
Jan Frait
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I. Countercyclical capital buffers – concept
3
Countercyclical capital buffer in Basel III (1)
• countercyclical capital buffer (CCB henceforth) is genuine macroprudential tool
• „optimists“ believe that the CCB could be used for taming a credit boom
• help the authorities to lean against the build-up phase of the cycle by raising the cost of credit, and therefore slowing down its provision, when they conclude that the stock of credit has grown to excessive levels relative to the benchmarks of the past experience
• this potential moderating effect on the build-up phase of the credit cycle should be viewed as a positive side benefit, rather than the primary aim of the CCB regime
4
Countercyclical capital buffer in Basel III (2)
• „pessimists“ presume that the quantitative impact of the CCB during the credit boom will be rather weak
• it should primarily protect the banking sector and general economy from the after-effects of excess aggregate credit growth that have often been associated with the build up of system-wide risk
• what kind of after-effects? …to maintain the flow of credit in the economy when the broader financial system experiences distress after a credit boom (smooth landing)
55
The role of a macroprudential authority regarding CCB
• to monitor credit and its dynamics (and potentially other indicators) and make assessments of whether system-wide risks are being built up
• based on this assessment, to decide whether the CCB requirement should be imposed (set above the zero value)
• to apply judgment to determine whether the CCB should increase or decrease over time (within the range of zero to 2.5% of risk weighted assets, in very strong credit booms even above 2.5%)
• to be prepared to remove the requirement on a timely basis if the system-wide risk crystallizes
66
The view of the Czech National Bank
• when Basel III was discussed, CNB in general • supported the CCB as a useful macroprudential tool as well as
harmonized methodology for setting it across countries • which would – however – allow sufficient flexibility for national
policymakers (reflecting different level of financial intermediation in converging economies and other specificities of individual countries)
• supported the Basel III approach to determine the bank-specific capital buffer (linked to the credit dynamics in the country where the loans were granted)
* EC: Consultation Document – Countercyclical Capital Buffer. 25 October 2010.
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Implementation of the buffer in CRD IV/CRR
• within consultations of the European Commission* (October – November 2010) – especially in the area of application of capital buffer for cross-border banks - the CNB
• rejected the alternatives approaches suggested by the Commission (determining the buffer according to the jurisdiction of the parent bank or according to the jurisdiction from which the credit is ultimately granted).
* EC: Consultation Document - Countercyclical Capital Buffer. 25 October 2010.
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II. CCB – calibration
99
The common reference guide: credit-to-GDP gap
• the common reference guide* for setting the CCB is based on the aggregate private sector credit-to-GDP gap
• a gap between currently observed value and the calculated long-term trend of private sector credit to GDP
• for calculation of the long-term trend, the Basel committee suggests using the Hodrick-Prescott filter with a high smoothing parameter
• buffer set as a function of the credit-to-GDP gap
Countercyclical capital buffer(% of RWA as a function of credit-to-GDP gap in pps)
-1.4-1.3-1.2-1.1
-1-0.9-0.8-0.7-0.6-0.5-0.4-0.3-0.2-0.1
00.10.2
0
0.5
1
1.5
2
2.5
3
3.5
4
-4 -2 0 2 4 6 8 10 12 14
Credit-to-GDP gap (in %)
* BCBS: Guidance for national authorities operating the countercyclical capital buffer. BIS, December 2010, pp. 4 and 8.
1010
CNB work on countercyclical capital buffers
• the CNB is focusing on the issue of how to calibrate the CCB in converging economies
• Financial Stability Report 2010/2011* responds to question “how the CCB would have been set if the regime had been existing before crisis?“ through the analysis of ten CEE countries in the period of strong credit growth 2003-2007
• conclusion: basic methodology recommended by Basel Committee for setting the CCB rate (credit-to-GDP gap calculated according to the purely statistical method of Hodrick-Prescott filter) is not appropriate for converging economies like the Czech Republic
• it is surely not appropriate for advanced countries previously experiencing lasting credit boom either!
* Geršl, Adam – Seidler, Jakub: Excessive credit growth as an indicator of financial (in)stability and its use in macroprudential policy. Thematic article, FSR 2010/2011, CNB.
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CEE converging countries and calculation of credit-to-GDP gap
1. short time-series (Basel recommends 20 years of quarterly data)2. fast credit growth is incorporated in the trend (convergence in
credit to GDP - initial low level of financial intermediation and catching up process)
Development of credit to GDP ratio in CEE countries(%)
Source: IMF IFS, CNB calculations
0
20
40
60
80
100
120
140
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Hungary Poland Romania
Slovenia Euro area
Development of credit to GDP ratio in CEE countries(%)
Source: IMF IFS, CNB calculations
0
20
40
60
80
100
120
140
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Bulgaria Estonia Latvia Lithuania Euro area
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CEE countries and buffer calculation – what makes things complex
3. banking sector restructuring (bad assets in the 1990s – especially CZ and SK, bank privatizations)
4. changes in the composition of credit to the private sector (increasing share of loans to households)
5. end-point bias of HP filter as an obstacle to practical conduct of macroprudential policy
Development of credit to GDP ratio in CEE countries(%)
Source: IMF IFS, authors' calculations
0
10
20
30
40
50
60
70
80
1998Q1 1999Q3 2001Q1 2002Q3 2004Q1 2005Q3 2007Q1 2008Q3
Czech Republic Slovak Republic
Stock of bank credit to the real sector in the Czech Republic(in CZK bil)
Source: Czech National Bank
0
200
400
600
800
1000
1200
1400
1600
1800
2000
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Non-financial corporations Households
13
Deleveraging and buffer calculation after a boom
• Růst úvěrů do privátního sektoru v eurozóně i po 2008 vs. s výrazné poklesy ve Velké Británii nebo USA.
Úvěry privátnímu sektoru v eurozóně, USA a V. Británii(leden 2002 = 100)
Pramen: ECBPozn.: pro EA a UK použita shodná metodika ECB
90
110
130
150
170
190
210
I.02 I.04 I.06 I.08 I.10
EA UK USA
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Application of the guide to the Czech Republic
• using HP filter with recommended lambda would indicate excess credit growth (even since 2003 if estimated „continuously“)
• holds even if other reasonable denominators are used (assets)
Bank credit to the real sector in relative terms(%)
Source: CNB, CZSO
0
10
20
30
40
50
60
70
1996 1998 2000 2002 2004 2006 2008 2010Credit-to-GDPCredit-to-financial-assetsCredit-to-assets
Credit gaps in the Czech Republic with alternative denominators(%)
Source: CNB, authors' calculations
-15
-10
-5
0
5
10
15
20
03/98 03/00 03/02 03/04 03/06 03/08 03/10
Credit-to-GDP gap
Credit-to-GDP gap (actual period estimation)
Credit-to-financial-assets gap
Credit-to-assets gap
15
Application of the guide to the Czech Republic
• when estimated in credit growth phase only (2004-2008), HP filter captures only short-term deviations
Credit-to-GDP and its trend (HP filter on data starting in 2004)(%)
Source: IMF IFS, CNB calculations
30
35
40
45
50
55
60
06/04 06/05 06/06 06/07 06/08 06/09
Estimated HP trend Credit-to-GDP
1616
Historical comparison does not reveal excessive credit in the Czech Republic (1)
• Czech Republic has lower level of credit to GDP than selected core EU countries when at similar level of economic development (in the 1980s)
• other features of credit growth in the Czech Republic also do not indicate the build up of system-wide risk (no FX loans to households; no external funding; high deposit-to-loan ratio; low LTV ratios)
• contrasts with e.g. Latvia that had comparatively much higher stock of credit in 2008, several „dangerous“ features of credit boom and lower level of GDP per capita
Credit to GDP for similar level of economic development(GDP per capita in 2005 USD = 17 ths USD; in %)
Source: IMF IFS, CNB calculations
0
10
20
30
40
50
60
70
80
90
100
CZ(2009)
IT(1986)
NL(1984)
AT(1984)
FR(1985)
ES(1990)
DE(1983)
Credit to GDP for similar level of economic development(GDP per capita in 2005 USD = 14 ths USD; in %)
Source: IMF IFS, CNB calculations
0
10
20
30
40
50
60
70
80
90
100
Latvia(2008)
IT (1984) ES (1988) AT (1985) DE (1985)
1717
Historical comparison does not reveal excessive credit in the Czech Republic (2)
• ....
Credit-to-GDP ratios for a similar level of economic development
Source: IMF IFS, WB WDI, authors' calculations
(in %; GDP per capita, in PPP constant 2005 international $; approximately 22, 500 for the Czech Rep as of 2010)
0
10
20
30
40
50
60
70
80
90
100
Czech Republic(2010)
Italy(1988)
Netherlands(1984)
Austria(1985)
France(1987)
Spain(1997)
Germany(1985)
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III. CCB – the way forward
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The discretion of policymakers is anchored in Basel III
• credit-to-GDP ratio should serve only as a guide*• rather than relying mechanistically on the credit/GDP guide,
authorities are expected to apply judgment in the setting of the buffer in their jurisdiction after using the best information available to gauge the build-up of system-wide risk
• in addition, the calculated long-term trend of the credit/GDP ratio is a purely statistical measure that does not capture turning points well*
• therefore, authorities should form their own judgments about the sustainable level of credit in the economy; they should use the calculated long-term trend simply as a starting point in their analysis
* BCBS: Guidance for national authorities operating the countercyclical capital buffer. BIS, December 2010, pp. 4 and 8.
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The alternative to HP filter: fundamental „out-of-sample“ method leads to different credit-to-GDP gaps and different potential buffers
• a way how to form judgment about the sustainable level of credit in the economy: • regressing the credit to GDP on a range of economic fundamentals (GDP per capita;
households consumption; inflation,FX loans to households; external funding; deposit-to-loan ratio; LTV ratios etc.), using data for developed countries
• applying the estimated elasticities „out of sample“, i.e. on CEE countries to calculate „equilibrium credit“
• in contrast to HP filter, the fundamental out-of-sample method takes into account the economic fundamentals influencing the level of credit in the economy
• the HP filter would not define some countries as in a situation of excess credit growth while fundamental method would (figures below in the table are calculated for 3Q 2008, i.e. just before the CEE countries were hit by the global financial crisis)
HP filter Out-of-sample HP filter Out-of-sampleBG 11.4 10.8 2.5 2.5CZ 9.5 -15.0 2.4 0.0EE 5.3 27.9 1.0 2.5LT 6.9 -8.3 1.5 0.0LV 1.0 19.6 0.0 2.5HU -1.4 -10.7 0.0 0.0PL 3.0 -23.3 0.3 0.0RO 6.1 -27.3 1.3 0.0SK 6.1 -22.8 1.3 0.0SI 5.4 5.5 1.1 1.1Source: authors' calculations
Credit-to-GDP gap (%)Countercyclical capital buffer
(% of RWA)
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Results of the „out-of-sample“ method in comparison to HP filter
Czech Republic
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
2000q1 2002q1 2004q1 2006q1 2008q1
HPgap OUTgap
Estonia
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
2000q1 2001q4 2003q3 2005q2 2007q1 2008q4
HPgap OUTgap
Latvia
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
2000q1 2001q4 2003q3 2005q2 2007q1 2008q4
HPgap OUTgap
22
Results of the „out-of-sample“ method in comparison to HP filter
Slovenia
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
2000q1 2002q1 2004q1 2006q1 2008q1 2010q1
HPgap OUTgap
Slovakia
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
2000q1 2002q1 2004q1 2006q1 2008q1
HPgap OUTgap
Poland
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
2000q1 2001q4 2003q3 2005q2 2007q1 2008q4
HPgap OUTgap
23
Results: comparison of HP and out-of-sample methods
Bulgaria
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
2000q1 2001q4 2003q3 2005q2 2007q1 2008q4
HPgap OUTgap
Hungary
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
2000q1 2001q4 2003q3 2005q2 2007q1 2008q4
HPgap OUTgap
Lithuania
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
2000q1 2001q4 2003q3 2005q2 2007q1 2008q4
HPgap OUTgap
Romania
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
2000q1 2002q1 2004q1 2006q1 2008q1 2010q1
HPgap OUTgap
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Countries above equilibrium credit
• it seems that for CEE countries, the out-of-sample method better predicts the problem countries
• empirical evidence shows that the four countries identified as being above equilibrium credit (LV, BG, EE, SI) and the two close to the border (HU and LT) did not show particularly high Tier 1 capital ratios before crisis in 2008 (except Bulgaria) and some of them experienced relatively high drop in RoE of banks
Credit-to-GDP gap via out-of-sample and Tier 1 ratio in 2008(gap in pps; Tier 1 capital ratio in 2008)
Source: IMF, authors' calculations
EESI
BGCZ
LT
LV
HU
PL
RO
SK
6
7
8
9
10
11
12
13
-40.0 -20.0 0.0 20.0 40.0
Credit-to-GDP gap via out-of-sample and change in RoE(gap in pps; change in RoE of banking sector in pps)
Source: IMF, authors' calculations
EE
SIBG
CZ
LT
LV
HUPLRO
SK
-70
-60
-50
-40
-30
-20
-10
0
10
-40.0 -20.0 0.0 20.0 40.0
25
Further developments
• to be fair, the out-of-sample method also has a number of drawbacks
• fundamental variables selection (housing prices seem to be a relevant variable, but can themselves suffer from bubbles)
• selection of advanced (sample) countries • different fundamentals in advanced (sample) countries versus
CEE countries at the current stage of development• estimation method suffers by losing country-specific constant
• the methodology is being developed further and made more robust to be more appropriate for practical implementation
• other methods and indicators are being tested as to their signaling properties for a built-up of systemic risk in converging economies
• the indicators for deciding on policy reversals are needed too
26
Policy approach – consistency vs. discretion
• The key issue is setting the long-term equilibrium trend(s)
clearly below
clearly above
time
Credit-to-GDP
?more indicators and judgment required
more optimistic equilibrium trajectory
less optimistic equilibrium trajectory
2727
Countercyclical capital buffers – the example of policy
• Credit-to-GDP cannot be a sole driver of countercyclical capital buffers setting – it is a lagging slow-motion variable staying above the historical norms during the initial stages of crisis.
• The indicators of credit cycle dynamics and other are therefore needed to guide the shifts in setting (credit growth, lending conditions, spreads etc.)
period of financial exuberance
time
Credit-to-GDP over financial cycle
turning point (start of crisis): credit-to-GDP still very high, but policy has to change sharply
period of financial distress
long-term „normal“ level of credit-to GDP
period of financial exuberance
time
Credit dynamics (e.g. y-o-y growth)
period of financial distress
turning point (start of crisis): credit growth falls, lending conditions tighten
CCB set to zero
CCB set to zero again
CCB set at maximum 2,5 %
2828
Conclusions
• flexibility embedded in the Basel III countercyclical capital buffer regime is a desirable element
• should be kept to a large extent in the EU regulation (CRD IV/CRR), the ESRB should keep the coordination and ex post monitoring role
• CEE converging countries are exactly the ones where detrending by HP filter can not work well in calibrating the buffer
• macroprudential research in CEE countries has to identify set of fundamental factors that could provide solid guidance for setting this instrument and using it in efficient way
Thank you for the attention
www.cnb.cz
Jan FraitHead of Financial Stability Department
Contact to the Financial Stability Department: E-mail: [email protected]
http://www.cnb.cz/en/financni_stability/
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References
• BANK OF ENGLAND (2009): The Role of Macroprudential Policy. Discussion Paper, November 2009. • BORIO C., FURFINE C. AND LOWE, P. (2001): Procyclicality of the financial system and financial stability:
issues and policy options”, in “Marrying the macro- and microprudential dimensions of financial stability”, BIS Papers, No. 1, March, pp. 1–57
• BORIO, C – SHIM, I. (2007): “What can (macro)-prudential policy do to support monetary policy. BIS Working Papers, no 242, December.
• BORIO, C. - P. LOWE, P. (2001): To provision or not to provision. BIS Quarterly Review, September 2001, pp. 36-48.
• BORIO, C. - WHITE, W. (2004): Whither monetary and financial stability? The implications of evolving policy regimes. BIS Working Paper, No. 147, February 2004.
• BORIO, C. (2003): Towards a macroprudential framework for financial supervision and regulation? BIS Working Paper, No. 128, February 2003. http://www.bis.org/publ/work128.pdf.
• BORIO, C. (2009), Implementing the macro-prudential approach to financial regulation and supervision, Banque de France Financial Stability Review, No. 13 — The Future of Financial Regulation, September 2009.
• BORIO, C.-DREHMANN, M. (2009), Towards an operational framework for financial stability: fuzzy measurement and its consequences. BIS Working Paper, No. 284, June 2009.
• CLEMENT, P. (2010): The term “macroprudential”: origins and evolution. BIS Quarterly Review, March 2010, pp. 59-67
• FRAIT, J., KOMÁRKOVÁ, Z. (2009): Instruments for curbing fluctuations in lending over the business cycle. Financial Stability Report 2008/2009, Czech National Bank, pp. 72-81.
• Frait, J., Komárek, Komárková, Z. (2011): Monetary Policy in a Small Economy after the Tsunami: A New Consensus on the Horizon? Czech Journal of Economics and Finance 61, No. 1, pp. 5-33.
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References
• Frait, J., Komárková, Z. (2011): Financial stability, systemic risk and macroprudential policy. Financial Stability Report 2010/2011, Czech National Bank, pp. 96-111; ISBN 978-80-87225-34-9
• Frait, Jan; Gersl, Adam; Seidler, Jakub; Credit growth and financial stability in the Czech Republic. World Bank Policy Research Working Paper; no. WPS 5771 2011/08/01 August 2011
• WHITE, W. (2006): Procyclicality in the financial system: do we need a new macrofinancial stabilisation framework?, BIS Working Papers, no 193, January.