Procyclicality and Macroprudential Policy

Procyclicality and Macroprudential Policy

Jan FraitJan Frait

I.Procyclicality and Provisioning

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 years due 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)

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.

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 been more supportive of liberal general

provisioning regimes and reserves than have accounting and 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.

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.


• 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)


• 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.


• 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.

• Half of NPLs is not overdue ... • Creation of LLP follows cycle, but not fully

10

LLP and NPL dynamics(bil. CZK, 12M MA)

Source: ČNB

-1

0

1

2

3

4

8/06 2/07 8/07 2/08 8/08 2/09 8/09 2/10 8/10 2/11 8/11

m-t-m change in LLP (12M MA)

m-t-m change in NPL (12M MA)

Struktura úvěrů v selhání (v %)

Nestandardní Pochybné ZtrátovéÚvěry v

selhání celkem

2009 37,8 21,0 41,2 100,02010 39,1 13,4 47,5 100,0

Bez prodlení Prodlení do 3MProdlení nad 3M

Úvěry v selhání celkem

2009 52,9 8,7 38,4 100,02010 51,8 9,6 38,6 100,0

Pramen: ČNB, výpočty ČNB

LLPR in CZ

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)


• 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 impaired loans) 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


• 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.

t

iitiit

iit SPLLGP

6

1

6

1


• Developments in provisioning funds in Spain after 2000 – developments of provisions‘ components

0

10.000

20.000

30.000

40.000

50.000

60.000

dic-00 jun-01 dic-01 jun-02 dic-02 jun-03 dic-03 jun-04 dic-04 jun-05 dic-05 jun-06 dic-06 jun-07 dic-07 jun-08 dic-08 jun-09

million €Total provisions Especific provisions General provisions

Source: Saurina, J. (2009): The Spanish experience of counter-cyclical regulation. Prague, October 23, 2009.


• 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, later on not covered …• never 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.


• Spanish system was rather simple – a kind of pre-dynamic provisioning:• not optimal, just one of potential solutions, • doubts 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 Commission to use it via CRD supported neither by industry nor by

supervisors (including the CNB).

Do the Czech banks provision procyclically?

Loan loss provisions/total loans and GDP growth (Czech Republic, 1998 - 2008)

Source: CNB, CZSONote: y-axis: GDP growth in %; x-axis: ratio of provisions to loans in %

-3

-2

-1

0

1

2

3

4

5

6

7

8

0 2 4 6 8 10 12 14

• 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)


• 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 2001–2011.

• Does it reflect procyclical behaviour?

• If yes, how strong are the non-procyclical features of banks‘ behaviour?

Loan Loss Provisions/Total Loans and GDP growth

(Czech Republic, 2001–2011)

Source: CNBNote: y-axis: GDP growth in %, x-axis: ratio of provisions to loans in %

-6

-4

-2

0

2

4

6

8

1 1.5 2 2.5 3


titititi

tittti

TACAPTALOANSLOANS

TAEARNgapUNEMPLGDPTALLP

,,7,6,5

,4321,

)/()/(ln

)/(_ln)/(

Variables:(i) macroeconomic: the growth rate of real GDP (ΔlnGDP),

the unemployment gap (UNEMPL_gap);(i) 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;

(ii) 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)).


Results of panel regression for loan loss provisionsVariables Coefficients Std. Deviations t

LLP/TA, lagged by 1Q 0,3390 0,5084 6,67***GDP growth -0,0003 0,0020 -1,74**Unemployment gap 0,0012 0,0006 1,84**Pre-tax profit 0,6565 0,0567 11,57***Loans growth -0,0022 0,0022 -1,00Loans/TA 0,0118 0,0048 2,46***Capital/TA -0,2230 0.0319 -6,98***No. of observations 172R2 - within (among banks) 0,942 R2 - overall 0,947R2 - between (over time) 0,993 rho 0,102

375,46 Prob > F 0,000F test of equality of constants for banks (FE)F (3,161) 2,24 Prob > F 0,0857

Note: The data were statistically significant at the ***1%, **5% or *10% level.

• 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 profit positively, capital ratio more likely negatively.


• 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 profit positively, capital ratio more likely negatively.

Results of panel regression for loan loss provisionsVariables Coefficients Std. deviations tLLP/TA, lagged by 1Q 0.701764 0.0242 28.96***GDP growth -0.000094 0.0000 -1.96**Unemployment gap 0.002375 0.0009 2.69***Pre-tax profi t 0.180381 0.0223 8.09***Loans growth 0.000010 0.0001 0.14Loans/TA 0.008817 0.0014 6.21***Capital/TA -0.019226 0.0099 -1.94**c -0.017629 0.0057 -3.11***

No. of observations 525R2 – within (between banks) 0.8650 R2 - overall (celková) 0.9604R2 – between (over time) 0.9813 rho 0.6625 F(7,503) 460.49 Prob >F 0.0000F test of equality of constants for banks (FE) F(14, 503) 7.22 Prob >F 0.0000

Note: The data were statistically significant at the ***1%, **5% or *10% level. Given the nature of the variablesunder review, a fixed-effects model was used. The F-test of equality of the constants for fixed effects rejects thehypothesis of equality at the 9% level of significance and thus partly confirms some small degree of specificityacross banks. We tested the panel data for non-stationarity using the Hadri panel unit root test.


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.).

II.Proposals for taming procyclicality

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).


• Expected loss approach (IASB, June 2009)• The expected cash flow approach - 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.


• 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.


• 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.


• 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 after its effect, and thus providing two measures of profitability, the ‘traditional’ accounting figure and a second figure struck after economic cycle reserving.

• Capital buffers under Basel III and CRD4 (conservation, countercyclical, systemic risk, SIFI) – now at the most advanced stage due to its attractiveness to the regulators and supervisors.

III.Capital buffers

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)

• 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.


• High (perceived) costs of scraping Basel II down was 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.


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 ...

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.


• The starting point is Basel III new regulatory capitalization minimums:1. New common equity ratio (Core Tier1, CT1) of 7%, split between a

4.5% minimum requirement and a conservation buffer of 2.5%.

2. A countercyclical buffer of up to 2.5% of common equity, implemented according to national circumstance.

3. A supplementary, non-risk-based leverage ratio, to be tested at 3%.

4. 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 range in which restrictions on distributions of profits are applied.


• The starting point is Basel III new regulatory capitalization minimums (cont.):

• Goldman Sachs view of Basel III (GS Global Investment Research):

1. CT1 ratio of 7% as the new regulatory minimum for banks of non-systemic importance - for banks deemed to be of systemic importance, the CT1 minimum is subject to an additional surcharge and is therefore to be set at a level above the 7% CT1 minimum.

2. A regulatory minimum is just that: a minimum. In practice, banks will aim to exceed the minimum to be on the safe-side; and exceeded it further, before capital return to shareholders is considered. 7% is not the “magic” number; rather, it is a floor.

3. From an equity investor’s perspective, the relevant level of capital is not the regulatory minimum but rather one above which all key parties—bank managements, regulators, debt holders, “the market”—would not object to capital being returned to shareholders. This level—the GS target capitalization—will also differ among banks.


• The starting point is Basel III new regulatory capitalization minimums (cont.):

Goldman Sachs view of Basel III


• The essence of CCB:• Calibration of CCB should be based on credit-to-GDP ratio and its deviation

from its long-term trend.

• The proposal uses a broad definition of credit that will capture all sources of debt funds for the private sector (including funds raised abroad) to calculate a starting buffer guide. Ideally the definition of credit should include all credit extended to households and other non-financial private entities in an economy independent of its form and the identity of the supplier of funds. .

• Conversely, the buffer would be released when, in the judgment of the authorities, the released capital would help absorb losses in the banking system that pose a risk to financial stability. This would help reduce the risk that available credit is constrained by regulatory capital requirements.

• Authorities in each jurisdiction will be responsible for setting the buffer add-on applicable to credit exposures to counterparties/borrowers in its jurisdiction.

• The buffer that will apply to an internationally active bank will reflect the geographic composition of the bank’s portfolio of credit exposures.


• The essence of CCB (cont.):• By design, the constraints imposed on banks with capital levels at the top of

the range would be minimal.

• The buffer range is divided into quartiles determining the percentage of earnings to be conserved (calibration not finished yet).


• The essence of CCB (cont.) - the example:• Minimum CT1 requirement for all banks is 4,5% of RWA + the capital

conservation buffer is set at 2,5% of RWA.

• Under this setting a bank with a CT1 ratio of 7,5% or higher would not be subject to any restrictions on distributions of capital as restrictions are only imposed in the range of 4,5% – 7%.

• If this bank becomes subject to a CCB add-on of 2%, the range in which restrictions on distributions are imposed becomes 4,5% – 9%.

• CT1 capital ratio of 7.5% is in the third quartile of this range and so, using the numbers in the table above, would be required to conserve 60% of earnings.

• 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.


41

• The CCB gives a national regulator wide discretion:• Calibration of CCB should be based on credit-to-GDP ratio and its deviation

from its long-term trend, but this will be common reference point only.

• The calculated long-term trend of the credit/GDP ratio is a purely statistical measure that does not capture turning points well. Authorities will form their own judgments about the sustainable level of credit in the economy.

• Authorities in each jurisdiction will be free to emphasise any other variables and qualitative information that make sense to them for purposes of assessing the sustainability of credit growth and the level of system-wide risk, as well as in taking and explaining buffer decisions.

• Particular consideration was given to the question of how to take account of jurisdictions with financial systems at different stages of development. Each jurisdiction will have the discretion to impose buffers above or below the guide buffer add-on level, subject to appropriate transparency and disclosure requirements.


42

• Credit-to-GDP is not enough:• Maybe a useful indicator for the risk accumulation phase.

• Only gradual decline after crises.

-10

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51

01

5

-16 -12 -8 -4 0 4 8 12 16

Median 25th perc. 75th perc.

Variable around crises

-10

010

2030

1980q1 1990q1 2000q1 2010q1

GB

credit_gdp_gap


43

• Mezní riziko vzniku krize je silně nespojité, zatímco časové řady makroveličin ne.


44

• Claudio Borio (BIS) – 2010: • Most promising real-time indicators of financial distress exploit the

paradox of financial instability to their advantage• Joint positive deviations (“gaps”) of credit-to-GDP ratio and asset prices

(especially real estate) from historical norms• Best signal of FD 2-4 years ahead (also out of sample)

• Signal of overstretched balance sheets on the back of aggressive risk-taking (“financial imbalances”)

• They also have information about output weakness and (less strong?) disinflation over similar horizons

• Why?• Credit-to-GDP gap: very rough measure of economy-wide leverage• Asset price gap: very rough measure of likelihood and size of reversal

• US example (Graph)


45

• Claudio Borio (BIS) – 2010:


46

• Claudio Borio (BIS) – 2010:

–40

–20

0

20

40

80 85 90 95 00 05

Credit/GDP Property prices

Private credit/GDP and property price gap1

Sweden


47

• BIS – 2010:

Countercyclical capital buffer: United States

0.0

0.5

1.0

1.5

2.0

2.5

80 85 90 95 00 05

Vertical shaded areas indicate the starting years of system wide banking crises.The countercyclical buffer is 0 when the value of the credit/GDP gap is below 2 and 2.5 when it is above 10 per cent; for gaps between 2 and 10 percent the buffer is calculated as 2.5/8 times the value of the credit/GDP gap exceeding 2 per cent.Source: BIS calculations

Countercyclical capital buffer: Spain

Works quite well – only once the stress is evident, it is necessary to release immediately and not not wait for decline in credit-to-GDP

0.0

0.5

1.0

1.5

2.0

2.5

80 85 90 95 00 05

Release indicators

Where will this lead?

• There is a risk that combination of redrafted Basel II combined with capital buffering, leverage limits and expected-loss-provisioning will produce something unexpected …

• There is a visible lack of coordination of authorities in terms of simultaneous considerations of both regulatory and accounting aspects.

• D. Tarullo (2008): „ … there is a strong possibility that the Basel II paradigm might eventually produce the worst of both worlds—a highly complicated and impenetrable process (except perhaps for a handful of people in the banks and regulatory agencies) for calculating capital but one that nonetheless fails to achieve high levels of actual risk sensitivity”...

• Still, if the cycle is driven by overly optimistic expectations, only combined effect of several other policies could do the job.

Money, regulation and supervisors courage

• The imbalances leading to current crisis were developing in a very complex manner due to the combined effect of globalization, financial market deregulation and increases in productivity that seemed to be more than temporary.

• Such a process was reflected in a build-up of optimistic expectations leading to „this time it will be different“.

• Monetary policy was really not much helpful, but not the major source of asset price booms (see IMF World Economic Outlook, October 2009).

• There was no “key source“, “major policy fault“, “most important wrongdoer“ behind the sources of crisis and a major difference in a single policy could not prevent it. • Or, do we really think that central bankers and supervisors were strong

enough to stop a high speed train with a massive political support?

• Or even, how strong would be the support of policy-makers in one country who would try to cut off the music when the whole world was still dancing?

Money, regulation and supervisors courage

• The lesson for myself – if the international economy in the future starts undergoing a dynamic drive again, accompanied by credit and asset price booms, the authorities should apply concerted set of microprudential and macroprudential measures to tame the immoderate optimism.

• Factors mitigating procyclicality embodied in regulation should ensure accumulation of buffers and better supervision should prevent the bank managers from taking excessive risks.

• Monetary policies might need to step in directly via interest-rate channel or indirectly via macroprudential/microprudential tools changing its transmission.

• Still, plenty of courage, luck and communication skills would be needed to succeed.

Thank You for Your Attention

Contact:

Financial Stability Department in the CNB: [email protected]

CNB: Financial Stability Reports, various issues - available at http://www.cnb.cz/en/financial_stability/

Jan FraitFinancial Stability Dept.Czech National BankNa Prikope 28CZ-11503 Prague

Tel.: +420 224 414430E-mail: [email protected]

References

• BANK OF ENGLAND (2009): The Role of Macroprudential Policy. Discussion Paper, November 2009. • BIKKER, J. A., METZEMAKERS, P. A. J. (2003): Bank Provisioning Behaviour and Procyclicality, DNB Staff

Reports No. 111, De Nederlandsche Bank• BORIO C., FURFINE C. AND LOWE, P. (2001): Procyclicality of the fi nancial 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.

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References

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References

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• WHITE, W. (2006): Procyclicality in the financial system: do we need a new macrofinancial stabilisation framework?, BIS Working Papers, no 193, January.

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• WOODFORD, M. (2010): Inflation Targeting and Financial Stability”. Presentation at the conference “The Future of Monetary Policy,” EIEF, Rome, September 30-October 1, 2010. http://www.columbia.edu/~mw2230/EIEF10_slides.pdf

Procyclicality and Macroprudential Policy

Documents

financial regulation

financial supervisors

financial restrictions

financial supervision

issue of procyclicality

war procyclicality

financial stability

accounting standards