Explainer - How does the Central Bank help to protect the banking system from economic ups and downs?

Making the banking system less vulnerable to economic ups and downs

A well-functioning banking system is good for the economy and good for consumers. One of the ways we promote a functioning banking sector is to make sure banks keep enough money – or capital – in reserve to cover unexpected losses. This is called their “capital requirements”. In order to strengthen the banking system after the financial crisis it was necessary to review how much money banks kept in reserve. This led to an extra capital requirement called the “countercyclical capital buffer” or CCyB being put in place. The CCyB is specifically designed to make the banking system more resilient and less vulnerable to economic ups and downs.

How the CCyB works

The economy, and the banking system, tend to go through cycles. Sometimes the pace of economic growth picks up and other times it slows down, or shrinks i.e. recession. If the economy grows too fast bank lending and property prices can increase at unsustainable rates. This can cause the economy to overheat and lead to a harmful downturn.

On the other hand, if the economy grows too slowly, or shrinks, there is the risk banks will suffer losses and cut lending. This can make an economic downturn worse. The CCyB works by forcing banks to keep more money on reserve when the economy is growing strongly and risks associated with overheating are increasing. This means they have more money on reserve to use as a buffer against any future losses. Meanwhile, at times of financial distress, the CCyB can be reduced to help maintain the flow of bank lending to the economy.

How the CCyB is different

The CCyB differs from banks’ other capital requirements because it can fluctuate. Most capital requirements are set as a fixed percentage of banks’ “risk-weighted assets” such as their loans and mortgages. The CCyB is also set as a percentage of these assets, but it can be adjusted up or down depending on what is happening in the economy. So when risks related to bank lending and economic growth are considered low the CCyB may be set at a low level (or even zero). But if bank lending, property prices, or other elements of the economy grow too fast and overheating risks increase, the CCyB can be adjusted upwards.

Who sets the CCyB?

The Central Bank of Ireland, in consultation with the European Central Bank (ECB), sets the CCyB on lending in Ireland. It is reviewed every three months to make sure it is at the appropriate level given what is happening in the economy. The CCyB has been set at 0% since April 2020.

Countercyclical Capital Buffer

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