Bank Capital Buffers Research Articles

Basel III countercyclical bank capital buffer estimation and its relation to monetary policy

This paper proposes a new model to estimate the countercyclical bank solvency capital buffer established in Basel III. The model lies in a flexible semi-nonparametric approach to capture the probability distribution of the capital adequacy ratio, but also a stochastic Ornstein–Uhlenbeck process that incorporates components of the cyclical behavior. We measure the risk of breaching the minimum capital threshold that separates the countercyclical capital buffer from other capital components and analyze its relationship with macroeconomic variables such as interest rates, credit levels, and credit-to-GDP gaps. Furthermore, a vector autoregressive model is estimated to test the existence of the bank-capital channel and the risk-taking channel. The application to Germany and the Netherlands shows that countercyclical buffers are more accurate when skewness and kurtosis are considered and the probability of breaching the regulatory threshold is sensitive to macroeconomic signals. Overall, our model seems to be a useful tool for monitoring prudential policy and as a guide to establish countercyclical capital buffers.

Buying Insurance at Low Economic Cost – the Effects of Bank Capital Buffer Increases Since the Pandemic

Buying Insurance at Low Economic Cost – the Effects of Bank Capital Buffer Increases Since the Pandemic

Bank capital buffers and lending, firm financing and spending: What can we learn from five years of stress test results?

We use bank-firm matched data to study how the capital buffers that large U.S. banks must satisfy to “pass” the Federal Reserve's stress tests impact banks’ lending and firms’ loan volumes, overall debt, investment, and employment. We find that larger stress-test capital buffers lead to reductions in banks’ lending, modest increases in loan rates and spreads, and reductions in new loan originations. However, we do not find an impact of higher capital buffers on firms’ overall debt, investment, and employment, suggesting that firms find other credit sources to substitute for the reduction in loans from banks that participate in the stress tests.

Global capital flows and the role of macroprudential policy

Can countercyclical bank capital buffers reduce the negative effects of global liquidity shocks? We use the Lehman Brothers bankruptcy as a natural experiment to document the role of the banking system as a transmission channel of global financial disturbances to the real economy. Using central bank administrative data, our results suggest that in the aftermath of the Lehman collapse the banking channel is responsible for 1.44% of the aggregate drop in investment and 0.58% of the drop in aggregate employment. In order to evaluate the effectiveness of counter-cyclical macroprudential policies, we model an open-economy with a banking sector. We compare the drop in actual GDP during the 2008 financial crisis against the counterfactual GDP had Basel III style counter-cyclical capital buffers (CCyB) been in place. We find that the GDP drop in the counterfactual scenario would have been 6 p.p. lower than in the data. We also demonstrate the beneficial effects of the CCyB in mitigating tail risk (GDP at Risk). We show that, over a 3–5 year horizon, the GDP distribution with an operational CCyB would have a higher mean and a much thinner left tail when compared to an economy without a CCyB.

The European Central Bank, the Single Supervisory Mechanism and the COVID-19 related economic crisis: a neofunctionalist analysis

ABSTRACT The COVID-19 pandemic triggered a major economic crisis worldwide. The monetary policy response of the European Central Bank (ECB) was fast and massive. The ECB also intervened on the supervisory side because, after the establishment of Banking Union, the ECB was given responsibility for banking supervision in the euro area through the Single Supervisory Mechanism (SSM). This paper explains the response of the ECB-SSM to the COVID-19 related economic crisis during 2020 and 2021, up until February 2022. These ECB actions include the reduction of bank capital buffers, the redefinition of non-performing loans, and the limitations on dividends and bonuses paid by banks. We adopt a neofunctionalist approach, which suggests that policies are developed at the EU level in response to need, whereby supranational actors and spillovers are particularly important. We offer some concluding insights into whether the ECB-SSM’s responses have led to a further deepening of integration.

Bank Capital Buffers and Bank Risks: Evidence from the Namibian Banking Sector

Purpose: This paper analysed the effects of bank’s risk on capital buffer in Namibia, in the absence of the consensus on the cyclical behavior of capital buffers. Design/methodology/approach: The study employed the autoregressive distributed lag (ARDL) modelling technique on quarterly data for the period 2001 to 2019. Findings: The study found the following: First, there is a long run relationship between the dependent variable and the independent variables. Second, the study showed that the ratio of NPLs to gross total loans negatively affect capital buffers in the short run, while it positively affects capital buffers in the long run. Furthermore, return on assets and liquidity negatively affects capital buffers in both the short and long run. On the contrary, bank size in form of log of total loans positively affects capital buffers in both the short and long run. Research limitations/implications: The unavailability of data of a long-term span is not desirable. Moreover, the limited data of certain variables narrowed the choice of a variety of variables that could be included in the study. Originality/value: The paper contributes to the hypothesized theory of countercyclical. The policy implication from these findings is that the presence of countercyclical relationship is in support of the transition from Basel II to Basel III to mitigate the procyclical as experienced under Basel II accords as documented in the literature. Future studies should focus on using a variety of variables to assess this relationship and see whether or not the outcome will be different.

Do capital buffers matter? Evidence from the stocks and flows of nonperforming loans

This paper investigates the determinants of the stocks and flows (both in- and outflows) of nonperforming loans (NPLs) by considering a bank-specific factor that is not adequately analysed in the literature, namely, bank capital buffers. Using unbalanced panel data with 6,087 bank-year observations for the 2006–2018 period and a two-step system generalised method of moments (GMM) estimation, we find that banks with higher levels of capital buffers (both in terms of Tier 1 and total capital) have fewer NPL stocks and generate fewer NPL inflows. When we control for the characteristics of the loan portfolio, real guarantees collected by the bank increase the stocks and flows of new, impaired loans, while personal guarantees favour the outflow of bad loans.

Bank capital buffer releases, public guarantee programs, and dividend bans in COVID-19 Europe: an appraisal

We analyse the recent policy decisions made by the European Central Bank and the national authorities related to capital and shareholders’ remuneration aimed at promoting banking credit supply in COVID-19-afflicted economies. We forecast the impact of the regulatory decisions based on the empirical literature and discuss the factors that reduce the banks’ incentives to expand their loan portfolios. We argue that the introduction of the dividend ban caused a surge in regulatory uncertainty and undermined banks’ market valuation raising the expected funding costs and contributing to the banks’ reluctance to make use of the capital buffers. We develop policy suggestions intended to mitigate this effect.

International evidence for the substitution effect of FX derivatives usage on bank capital buffer

Banks are the most important users in the foreign exchange (FX) derivatives market, while the effect of FX derivatives usage on bank capital buffer is hitherto underexplored. We construct an international sample consisting of non-US banks from 59 economies, and examine the relationship between them. We find that banks with more FX derivatives have lower capital buffers, suggesting that FX derivatives usage is a substitute for capital buffer, and banks use FX derivatives largely for risk management purpose. The substitution effect is more significant for non-dealer banks, banks with high capital buffers, and banks in economies with floating currency system. It is also more significant when the FX rate and stock market are volatile. Our findings support policymakers, especially in developing economies, in promoting the development of FX derivatives market to facilitate the risk management of banks.

Compositional effects of bank capital buffers and interactions with monetary policy

We investigate the impact of capital requirements on bank lending across institutional sectors, focusing on their transmission channel and the interaction with monetary policy. By employing confidential loan-level data for the euro area, we find that the reaction of banks to capital surcharges for Other Systemically Important Institutions (O-SII) depends on the level of the required buffer and the institutional sector of the borrowing counterpart. Tighter requirements correspond to stronger lending contractions with targeted banks curtailing their lending mostly towards credit institutions. Loan supply to non-financial corporations is almost unchanged, mainly as a result of the incentives embedded in the ECB's targeted long-term refinancing operations. Our results provide evidence on the interaction between macroprudential and monetary policy, and the positive effects of combining two different sets of incentives to support the resilience of the banking system and credit supply to the real economy.

A note on regulatory responses to COVID-19 pandemic: Balancing banks’ solvency and contribution to recovery

We discuss the implications on banks and the economy of prudential regulatory intervention to soften the treatment of non-performing exposures (NPEs) and ease bank capital buffers. We apply these easing measures on a sample of Globally Systemically Important Banks (G-SIBs) and show that these banks can play a constructive role in sustaining economic growth during the COVID-19 pandemic. In addition, an empirical analysis shows that prudential regulatory responses to COVID-19 along with high regulatory capital and low non-performing loans ratios are positively associated with economic growth. Thus, banks should maintain high capital ratios in the medium-term horizon to absorb future losses, as the effect of COVID-19 on the economy might take time to fully materialize.

Bank Capital Buffers and Optimal Diversification Strategies During and after the Great Financial Crisis

Bank Capital Buffers and Optimal Diversification Strategies During and after the Great Financial Crisis

Bank Capital Buffers and Lending, Firm Financing and Spending: What Can We Learn from Five Years of Stress Test Results?

Bank Capital Buffers and Lending, Firm Financing and Spending: What Can We Learn from Five Years of Stress Test Results?

Usability of Bank Capital Buffers: The Role of Market Expectations

Usability of Bank Capital Buffers: The Role of Market Expectations

Un-used Bank Capital Buffers and Credit Supply Shocks at SMEs during the Pandemic

<ns2:p>Did banks curb lending to creditworthy small and mid-sized enterprises (SME) during the COVID-19 pandemic? Sitting on top of minimum capital requirements, regulatory capital buffers introduced after the 2008 global financial crisis (GFC) are costly regions of "rainy day" equity capital designed to absorb losses and provide lending capacity in a downturn. Using a novel set of confidential loan level data that includes private SME firms, we show that "buffer-constrained" banks (those entering the pandemic with capital ratios close to this regulatory buffer region) reduced loan commitments to SME firms by an average of 1.4 percent more (quarterly) and were 4 percent more likely to end pre-existing lending relationships during the pandemic as compared to "buffer-unconstrained" banks (those entering the pandemic with capital ratios far from the regulatory capital buffer region). We further find heterogenous effects across firms, as buffer-constrained banks disproportionately curtailed credit to three types of borrowers: (1) private, bank-dependent SME firms, (2) firms whose lending relationships were relatively young, and (3) firms whose pre-pandemic credit lines contractually matured at the start of the pandemic (and thus were up for renegotiation). While the post-2008 period saw the rise of banking system capital to historically high levels, these capital buffers went effectively unused during the pandemic. To the best of our knowledge, our study is the first to: (1) empirically test the usability of these Basel III regulatory buffers in a downturn, and (2) contribute a bank capital-based transmission channel to the literature studying how the pandemic transmitted shocks to SME firms.</ns2:p>

How Do Bank Capital and Capital Buffer Affect Risk: Empirical Evidence from Large US Commercial Banks

Abstract This research aims to investigate the influence of bank capital, risk-based capital and bank capital buffers on the behaviour of bank risk-taking by applying GMM on the data of US commercial banks ranges from 2002 to 2018. The findings show that bank capital has a positive influence on total risk. However, risk-based capital and capital buffer have a negative impact on total risk. In addition, the results showed that the relationship between bank asset risk and bank capital, risk-based capital and a capital buffer is negative in pre, amid and post-crisis periods. The findings also reveal that the result of bank capital, risk-based capital and a capital buffer is not similar in case of well, adequately, under, significantly under, and critically undercapitalized banks. Our conclusions have numerous implications for policymakers and regulators in the banking sector.

Bank Capital Buffer and Economic Growth: New Insights from the US Banking Sector

This research intends to explore the relationship between capital buffer, nominator effect, denominator effect, and economic growth for large insured commercial banks of the USA. The study applied a two-step system Generalized Method of Moment (GMM) framework by taking the unique and comprehensive dataset over the period extending from 2002 to 2018. The research found a countercyclical relationship between a capital buffer and economic growth. In the case of well-capitalized banks, this relationship is more critical than adequately capitalized banks. In the case of low-liquid banks, counter-cyclicality is more significant than high-liquid banks. The results also suggest the pro-cyclical relationship between nominator, denominator, and economic growth. The results remain consistent and robust with the use of the tier-one capital buffer ratio. The findings have implications for regulators to incorporate the counter-cyclicality between the capital buffer and economic growth, while formulating the policies for capital requirements in the future.

A Note on Regulatory Responses to Covid-19 Pandemic: Balancing Banks’ Solvency and Contribution to Recovery

We see spikes in unemployment rates and negative economic growth during the COVID-19 pandemic. Governments are responding with aggressive monetary expansions and large-scale economic relief plans. We discuss the implications on banks and the economy of prudential regulatory intervention to soften the treatment of non-performing loans and ease bank capital buffers. We apply these easing measures on a sample of Globally Systemically Important Banks (G-SIBs) and show that these banks can play a constructive role in sustaining economic growth during the COVID-19 pandemic. However, softening the treatment of non-performing loans along with easing capital buffers should not undermine banks’ solvency in the recovery period. Banks should maintain usable buffer in the medium-term horizon to absorb future losses, as the effect of COVID-19 on the economy might take time to fully materialise.

Direct and indirect impacts of European banks’ regulation

This paper examines whether bank regulation and supervision have independent effects on the capital buffer and insolvency risk or their effects are channelled through the business cycle and income diversification. The findings show that regulatory capital index and supervisor power index have both the direct effect on bank capital buffer as well as bank risk and indirect effects via business cycle, whereas restriction on bank activities indirectly channels its effects through income diversification. Economic downturn with tighter capital regulation diminishes the benefit of the capital buffer. The restriction on bank activities policy is not effective for EU banks that highly involve in risk-taking activities. Increasing official supervision related to the change in the business cycle only brings benefit to capital buffer but harms banks' stability. Regulators should adjust capital regulation on the business cycle, introduce the tighter restriction on bank activities and an appropriate supervision control to reduce bank risk-taking behaviour.

Assessing the cyclical behaviour of bank capital buffers in a finance-augmented macro-economy

This paper empirically analyses how the banks’ capital buffers change with the business cycle. We extract the cycle component using univariate and multivariate filters to document how buffers behave. We also account for the impact of financial factors on capital buffers over the business cycle. Using a large panel of banks for the period 2000–2014, we document evidence that once we account for the impact of financial factors on the business cycle, capital buffers behave more pro-cyclically than previously found in the literature. Furthermore, we provide evidence that large commercial banks react differently to business cycle movements compared to small banks. Overall, these results have important implications for the development of macroprudential policy tools for the global financial system.