Basel III CounterCyclical Buffer

8/7/2019 Basel III CounterCyclical Buffer

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Basel iii Compliance Professionals Association (BiiiCPA)www.basel-iii-association.com

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Basel iii Compliance Professionals Association (BiiiCPA)1200 G Street NW Suite 800 Washington, DC 20005-6705 USA

Tel: 202-449-9750 Web: www.basel-iii-association.com

Basel III: The Countercyclical buffer A. Introduction

Losses incurred in the banking sector can be extremely large when adownturn is preceded by a period of excess credit growth.

These losses can destabilise the banking sector and spark a vicious circle,whereby problems in the financial system can contribute to a downturn inthe real economy that then feeds back on to the banking sector.

These interactions highlight the particular importance of the bankingsector building up additional capital defences in periods where the risksof system-wide stress are growing markedly.

The countercyclical buffer aims to ensure that banking sector capitalrequirements take account of the macro-financial environment in whichbanks operate.

It will be deployed by national jurisdictions when excess aggregate creditgrowth is judged to be associated with a build-up of system-wide risk toensure the banking system has a buffer of capital to protect it againstfuture potential losses.

This focus on excess aggregate credit growth means that jurisdictions arelikely to only need to deploy the buffer on an infrequent basis.

The buffer for internationally-active banks will be a weighted average of the buffers deployed across all the jurisdictions to which it has credit

exposures.




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This means that they will likely find themselves subject to a small bufferon a more frequent basis, since credit cycles are not always highlycorrelated across jurisdictions.

The countercyclical buffer regime consists of the following elements:

(a) National authorities will monitor credit growth and other indicatorsthat may signal a build up of system-wide risk and make assessments of whether credit growth is excessive and is leading to the build up of system-wide risk.

Based on this assessment they will put in place a countercyclical bufferrequirement when circumstances warrant.

This requirement will be released when system-wide risk crystallises ordissipates.

(b) Internationally active banks will look at the geographic location of their private sector credit exposures and calculate their bank specificcountercyclical capital buffer requirement as a weighted average of therequirements that are being applied in jurisdictions to which they havecredit exposures.

(c) The countercyclical buffer requirement to which a bank is subject will

extend the size of the capital conservation buffer.

Banks will be subject to restrictions on distributions if they do not meetthe requirement.




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B. National countercyclical buffer requirements

Each Basel Committee member jurisdiction will identify an authoritywith the responsibility to make decisions on the size of thecountercyclical capital buffer.

If the relevant national authority judges a period of excess credit growthto be leading to the build up of system-wide risk, they will consider,together with any other macroprudential tools at their disposal, putting inplace a countercyclical buffer requirement.

This will vary between zero and 2.5% of risk weighted assets, dependingon their judgement as to the extent of the build up of system-wide risk.

The document entitled Guidance for national authorities operating thecountercyclical capital buffer, sets out the principles that nationalauthorities have agreed to follow in making buffer decisions.

This document provides information that should help banks tounderstand and anticipate the buffer decisions made by nationalauthorities in the jurisdictions to which they have credit exposures.

To give banks time to adjust to a buffer level, a jurisdiction willpre-announce its decision to raise the level of the countercyclical buffer

by up to 12 months.

Decisions by a jurisdiction to decrease the level of the countercyclicalbuffer will take effect immediately.

The pre-announced buffer decisions and the actual buffers in place for allCommittee member jurisdictions will be published on the BIS website.




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C. Bank specific countercyclical buffer

Banks will be subject to a countercyclical buffer that varies between zeroand 2.5% to total risk weighted assets.

The buffer that will apply to each bank will reflect the geographiccomposition of its portfolio of credit exposures.

Banks must meet this buffer with Common Equity Tier 1 or other fullyloss absorbing capital or be subject to the restrictions on distributions setout in the next Section.

Internationally active banks will look at the geographic location of theirprivate sector credit exposures (including non-bank financial sector

exposures) and calculate their countercyclical capital buffer requirementas a weighted average of the buffers that are being applied in jurisdictionsto which they have an exposure.

Credit exposures in this case include all private sector credit exposuresthat attract a credit risk capital charge or the risk weighted equivalenttrading book capital charges for specific risk, IRC and securitisation.

The weighting applied to the buffer in place in each jurisdiction will bethe bank’s total credit risk charge that relates to private sector credit

exposures in that jurisdiction, divided by the bank’s total credit risk charge that relates to private sector credit exposures across alljurisdictions.

For the VaR for specific risk, the incremental risk charge and thecomprehensive risk measurement charge, banks should work with theirsupervisors to develop an approach that would translate these chargesinto individual instrument risk weights that would then be allocated to thegeographic location of the specific counterparties that make up thecharge.




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However, it may not always be possible to break down the charges in thisway due to the charges being calculated on a portfolio by portfolio basis.

In such cases, the charge for the relevant portfolio should be allocated tothe geographic regions of the constituents of the portfolio by calculatingthe proportion of the portfolio’s total exposure at default (EAD) that isdue to the EAD resulting from counterparties in each geographic region.

D. Extension of the capital conservation buffer

The countercyclical buffer requirement to which a bank is subject isimplemented through an extension of the capital conservation bufferdescribed in section III.

The table below shows the minimum capital conservation ratios a bank must meet at various levels of the Common Equity Tier 1 capital ratio.

When the countercyclical capital buffer is zero in all of the regions towhich a bank has private sector credit exposures, the capital levels andrestrictions set out in the table are the same as those set out in section III.




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For illustrative purposes, the following table sets out the conservationratios a bank must meet at various levels of Common Equity Tier 1 capitalif the bank is subject to a 2.5% countercyclical buffer requirement.

E. Frequency of calculation and disclosure

Banks must ensure that their countercyclical buffer requirements arecalculated and publically disclosed with at least the same frequency astheir minimum capital requirements.

The buffer should be based on the latest relevant jurisdictionalcountercyclical buffers that are available at the date that they calculatetheir minimum capital requirement.

In addition, when disclosing their buffer requirement, banks must alsodisclose the geographic breakdown of their private sector creditexposures used in the calculation of the buffer requirement.




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F. Transitional arrangements

The countercyclical buffer regime will be phased-in in parallel with thecapital conservation buffer between 1 January 2016 and year end 2018becoming fully effective on 1 January 2019.

This means that the maximum countercyclical buffer requirement willbegin at 0.625% of RWAs on 1 January 2016 and increase each subsequentyear by an additional 0.625 percentage points, to reach its final maximumof 2.5% of RWAs on 1 January 2019.

Countries that experience excessive credit growth during this transitionperiod will consider accelerating the build up of the capital conservationbuffer and the countercyclical buffer.

In addition, jurisdictions may choose to implement larger countercyclicalbuffer requirements. In such cases the reciprocity provisions of theregime will not apply to the additional amounts or earlier time-frames.

Documents

Basel III CounterCyclical Buffer