Question

On 16 March 2020, Hong Kong Monetary Authority (HKMA) announced that “… the countercyclical capital buffer (CCyB) for Hong Kong is being reduced from 2.0% to 1.0% with immediate effect.”

a. Briefly explain the measure ‘countercyclical capital buffer’ under the Basel III Regulatory Capital Framework.

b. Why HKMA would like to reduce the ‘countercyclical capital buffer’ at this moment?

Answer 1

The package of reforms commonly known as Basel III is a comprehensive set of measures developed by the Basel Committee on Banking Supervision (BCBS) to address the fault lines in the financial system exposed by the Great Financial Crisis. One of these fault lines was the lack of a system-wide approach to financial sector risks, a so-called macroprudential perspective that aims to promote financial stability and mitigate systemic risk.

To address this shortcoming, Basel III introduces two buffers that apply to all banks: the capital conservation buffer and the countercyclical capital buffer. Two other macroprudential elements in the post-crisis regulatory response, the specific capital surcharge for global systemically important banks (G-SIBs) and the total loss-absorbing capacity (TLAC) requirement, apply only to G-SIBs and are covered in two dedicated Executive Summaries.

The countercyclical capital buffer (CCyB) aims to protect the banking sector from periods of excess aggregate credit growth that have often been associated with the build-up of system-wide risks. The CCyB framework became fully effective as of 2019.

Basel III requires that the CCyB be activated and increased by authorities when they judge aggregate credit growth to be excessive and to be associated with a build-up of system-wide risk. The buffer would subsequently be drawn down in a downturn to help ensure that banks maintain the flow of credit in the economy.

The BCBS also published guidelines for authorities making CCyB decisions. This includes a requirement for authorities to adopt an internationally consistent common buffer guide, based on the aggregate private sector credit-to-GDP ratio. This guide provides a common anchor for authorities to decide on the appropriate level of the buffer, with authorities free to rely on other indicators as well when deciding on the appropriate CCyB rate.

The CCyB varies between 0 and 2.5% of total risk-weighted assets and must be met with CET1 capital. Basel III requires banks to calculate and publish their CCyB requirements with at least the same frequency as their minimum capital requirements. As banks need time to adjust to an increase in buffer requirements, a jurisdiction is required to pre-announce its decision to raise the CCyB level by up to 12 months. On the other hand, decisions by a jurisdiction to decrease the level of the CCyB will take effect immediately.

The CCyB is implemented as an extension of the capital conservation buffer. Accordingly, banks that fall below their CCyB requirement are subject to automatic distribution restriction.The CCyB also introduces a unique feature of jurisdictional reciprocity. An authority that activates the buffer in a jurisdiction is expected to promptly inform its foreign counterparts. In turn, authorities in other jurisdictions should require their banks to apply the buffer for exposures in that jurisdiction. This reciprocal mechanism seeks to minimise the degree of cross-border spillovers and regulatory arbitrage. Reciprocity is mandatory for all BCBS member jurisdictions for a CCyB up to 2.5%. A bank's CCyB rate is calculated as the weighted average of CCyB rates set by the jurisdictions where it has exposures.

b)Lowering the countercyclical capital buffer at this juncture will allow banks to be more supportive to the domestic economy and help mitigate the economic cycle.