The countercyclical capital buffer (CCyB) is a macro-prudential policy tool where the capital requirement varies over time. In essence, the CCyB looks to ensure that banking sector capital requirements take account of the cyclical variations in the macro-financial risk environment.

By increasing capital requirements during cyclical upturns, when risks are increasing, the CCyB should enhance the resilience, or loss absorption capacity, of the banking sector. The subsequent release of the buffer, when risks materialise, should limit the potential for the banking sector to amplify risks in such circumstances. If minimum regulatory capital requirements were to result in a contraction in the supply of credit during such periods it could make the downturn worse.

The CCyB was one element of the global regulatory framework put forward by the Basel Committee on Banking Supervision (BCBS) in the aftermath of the financial crisis of the mid-to-late 2000s. It has been in operation across Europe since 2016 under the Capital Requirements Directive (CRD) IV. In 2019, this was amended by the CRD V, which was transposed into Irish law in 2020 (Statutory Instrument No. 710/2020). In addition to banks, the CCyB applies to MiFID investment firms that are subject to the Capital Requirements Regulation and CRD V.

The Central Bank of Ireland is the authority in Ireland responsible for setting the CCyB. This power was designated to the Central Bank in European Union (Capital Requirements) Regulations 2014 which transposes the CRD IV into Irish law  and was amended by European Union (Capital Requirements) (Amendment) Regulations 2020.

In the context of the Single Supervisory Mechanism (SSM) the ECB assesses the CCyB decisions of national designated authorities and if necessary has the power to set a higher rate. As such, the CCyB rate set by the Central Bank is done so having consulted with the ECB.

In general, the CCyB rate will be set between 0% and 2.5% of risk exposures.

However, if justified by exceptional circumstances, the rate can be set above 2.5%.

No.

Where the Central Bank announces an increase in the CCyB rate a phase-in period applies before the higher rate becomes effective. The phase-in period will generally be 12 months although a shorter period can be applied in exceptional circumstances.

However, where the CCyB rate is released or reduced the lower rate comes into effect immediately.

Formally, CCyB decisions are taken by the Governor. Prior to any decision, the issue is discussed at the Macro-prudential Measures Committee (MMC) which acts as an advisory committee to the Governor in this regard. The Central Bank’s Financial Stability Committee and the ECB are also consulted in advance of a decision.

As a member of the SSM CCyB assessments conducted by the Central Bank are without prejudice to any powers of the ECB under the SSM Regulations.

The guiding principle that informs the CCyB rate decisions of the Central Bank is promoting banking sector resilience against cyclical systemic risk. This objective requires the buffer to be built up in advance of the realisation of systemic risk/financial stress. As such, the Central Bank considers it important that the CCyB is in place at a sufficiently early stage to allow it to have a practical beneficial effect in a downturn. This in turn provides scope for the release of the buffer to limit the pro-cyclicality of bank lending during those times.

When such a downturn or the materialisation of cyclical systemic risk is identified, the Central Bank expects to reduce the buffer rate to a level consistent with mitigating pro-cyclicality. This includes reducing the buffer rate to zero, if necessary to limit the impact of the downturn on credit supply.

Existing vulnerabilities within the system may also frame the context for CCyB rate setting. Where conditions exist which leave the economy especially susceptible to a downturn or the materialisation of cyclical systemic risk it may be prudent to look to have a higher level of resilience built into the system, than would otherwise be the case.

When there is a sustained trajectory in indicators related to emerging cyclical systemic risk the Central Bank expects to maintain a positive CCyB rate. When that trajectory is persistent or reflects emerging imbalances, the buffer rate is expected to be above 1%.

The level of the buffer will be informed by the level of resilience expected to be sufficient to support the sustainable provision of credit to the real economy in a subsequent downturn.

The primary objective underlying Central Bank CCyB decisions is promoting banking sector resilience with a view to ensuring a sustainable provision of credit to the real economy. Nonetheless, increasing capital requirements during the upswing of the financial cycle can potentially have a damping effect on the build-up of the cycle itself. However research on the impact of the CCyB on the upswing in the financial cycle points to the effect being somewhat uncertain and can depend on individual circumstances.

Therefore, while there may be cases where a potential curtailment of the upswing of the financial cycle arising from CCyB decisions would be viewed by the Central Bank as a positive in curbing the emergence of systemic risk, this is not the primary motivation. Mitigating pro-cyclicality and curbing the downswing of the credit cycle is consistent with banking system resilience being the primary CCyB objective.

A broad set of quantitative indicators are used to inform policymaker judgement in setting the CCyB rate. There is no automatic link between any indicator(s) and the CCyB rate. The use of quantitative indicators is in line with ESRB Recommendation 2014/1.

The broad set of indicators used to inform CCyB decisions covers areas such as:

• Credit developments, including but not limited to the credit gap
• Dynamics in real estate markets
• Macroeconomic variables
• External imbalances
• Bank balance sheets.

In addition, in circumstances where the prompt release of the buffer may be important to mitigate pro-cyclicality it is expected that such decisions will take account of market-based data e.g. measures of market stress and volatility.

Yes, the Central Bank calculates and publishes the credit gap every quarter as part of its review of the CCyB rate.

The credit gap was given a prominent, although not dominant, role in the CCyB framework due to research showing it was the best single leading indicator of systemic banking crises. See Drehmann et. al 2010 (PDF).

However, the standardised credit gap can have some undesirable properties and may therefore not be applicable in all countries and at all times. These shortcomings can arise from both the data employed and/or the statistical approach used.

Given the structure and idiosyncrasies of the Irish economy, the Central Bank calculates a national specific credit gap as well as the standardised credit gap. The national specific measure utilises a narrower measure of credit and economic activity, than the standardised measure, which better reflect dynamics in the domestic economy. In addition, the Central Bank has developed the model-based alternative credit gap, which is described in O’Brien, O’Brien and Velasco (2018). The Central Bank also continues to investigate and assess alternative methodologies which may provide more meaningful and intuitive estimates for the credit cycle in Ireland.

The CCyB rate is reviewed by the Central Bank every three months.

The outcome of each review is published on the Central Bank’s website.

In its role as designated authority the Central Bank sets the CCyB rate applicable to the Irish credit exposures of institutions. Similarly, other designated authorities set the CCyB rate applicable to exposures within their respective jurisdictions.

The buffer rate for each individual institution, known as the institution specific capital buffer rate, is the exposure-weighted average of the CCyB rates that apply in the jurisdictions in which the institution has relevant credit exposures. This institution specific CCyB rate is then applied to a firms total risk-weighted assets to determine the € amount of its institution specific countercyclical capital buffer.

Stylised example of institution specific CCyB

Given the highly integrated nature of the EU financial sector, reciprocity is an essential element of the macro-prudential framework. Reciprocity aims to increase the effectiveness of macro-prudential measures by reducing cross-border leakages and by minimising negative cross-border effects.

Under CRD IV, CCyB rates set between 0% and 2.5% are subject to mandatory reciprocity. As such CCyB rates set within the EU apply to banks authorised in all Member States with relevant credit exposures and not just the banks authorised in the Member State in question.

Rates in excess of 2.5% are subject to voluntary reciprocity among EU Member States, although the ESRB has recommended full reciprocation in all cases.

The ESRB is responsible for the macro-prudential oversight of the EU financial system and the prevention and mitigation of systemic risk. In pursuit of its macro-prudential mandate, the ESRB monitors and assesses systemic risks and, where appropriate, issues warnings and recommendations. Recommendation 2014/1 provides guidance on the setting of countercyclical capital buffer rates.

The ESRB maintains a record of CCyB announcements and the rates in effect throughout Europe. Following each CCyB rate change, the Central Bank notifies the ESRB of its decision.