The Countercyclical Capital Buffer

A capital buffer is an additional capital that financial organisations must retain over and beyond their basic capital requirements. Regulations promoting the construction of adequate capital buffers are intended to limit the procyclical nature of lending by encouraging the formation of countercyclical buffers, as outlined in the Basel Committee on Banking Supervision’s Basel III regulatory reforms. Capital buffers differ from and may surpass the central bank’s reserve requirements. This article will learn about CounterCyclical Capital Buffer and Capital conservation buffer. Also, What is the difference between a capital conservation buffer and a countercyclical buffer? 

What is a capital buffer? 

A capital buffer is an additional capital that financial organisations must retain over and beyond their basic capital requirements. Regulations promoting the construction of adequate capital buffers are intended to limit the procyclical nature of lending by encouraging the formation of countercyclical buffers, as outlined in the Basel Committee on Banking Supervision’s Basel III regulatory reforms. Capital buffers differ from and may surpass the central bank’s reserve requirements. The Basel Committee on Banking Supervision issued official regulatory requirements in December 2010, intending to make the global banking system more resilient, particularly when it comes to liquidity concerns. Countercyclical capital buffers, which are determined by Basel Committee member jurisdictions and vary according to a percentage of risk-weighted assets, and capital conservation buffers, built up outside of periods of financial stress, are among the capital buffers identified in Basel III reforms. Banks increase lending during periods of economic expansion and decrease lending when the economy declines. When banks run out of money, they have two options: raise more capital or cut back on lending. Businesses may find finance more expensive or unavailable if banks cut back on lending.

What is a Countercyclical Capital Buffer? 

This global regulatory framework presents the details of worldwide regulatory criteria on bank capital adequacy and liquidity, including a countercyclical capital buffer for more resilient banks and banking systems. The countercyclical capital buffer is intended to guarantee that capital requirements for the banking sector consider the macroeconomic environment in which banks operate. Its main goal is to use a capital buffer to fulfil the broader macroprudential goal of protecting the banking industry against periods of excess aggregate credit expansion, which have been linked to the accumulation of system-wide risk. The CCCB, on the other hand, differs from other kinds of capital adequacy in that it seeks to assist a bank in mitigating the effects of a downturn or distressed economic conditions. With the CCCB, banks are obligated to set aside a larger share of their capital during rapid loan growth so that the capital can be released and used during periods of economic difficulty.

What is a capital conservation buffer? 

When banks incur losses, the capital conservation buffer guarantees that they have an additional layer of useful capital from which to draw. According to Basel standards, the CCB was to be implemented in 0.625 percent increments, with the entire CCB of 2.5 per cent to be implemented by March 31, 2019. Implemented it following the global financial crisis of 2008 to strengthen banks’ ability to endure difficult economic situations. It was a thorny issue between the RBI and the government in 2018. It was decided to postpone it for a year, to March 2020, following the change of guard at the central bank. Automatic safeguards kick in if a bank’s CCoB falls below 2.5 per cent, limiting the amount of dividend and bonus payments the bank can make. As the bank’s capital ratio approaches the required minimum, distribution limits become more severe. At each capital distribution date, must compute the applicable conservation norms. Apart from these restrictions, a bank will be allowed to go on business when its capital conservation buffer is depleted.

Conclusion:

A capital buffer is an additional capital that financial organisations must retain over and beyond their basic capital requirements. And it has two categories, Countercyclical Capital Buffer and capital conservation buffer. The countercyclical capital buffer is intended to guarantee that capital requirements for the banking sector consider the macroeconomic environment in which banks operate. When banks incur losses, the capital conservation buffer guarantees that they have an additional layer of useful capital from which to draw. Also, we saw the difference between capital conservation buffer and countercyclical buffer. About how the Central Bank imposes a countercyclical buffer, there are a lot of details provided in this article.