kom (2018) 0172 - Ingen titel

Europaudvalget 2018
KOM (2018) 0172
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EUROPEAN

COMMISSION

Brussels, 9.4.2018

SWD(2018) 89 final

COMMISSION STAFF WORKING DOCUMENT

Accompanying the document

REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND

THE COUNCIL

on Effects of Regulation (EU) 575/2013 and Directive 2013/36/EU on the Economic Cycle

{COM(2018) 172 final}

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TABLE OF CONTENTS

1. Introduction.................................................................................................................. 2

2. Background……………………………………............................................................2

3. Methodology............................................ .................................. ..................................5

4. Assessing the cyclicality of regulatory capital requirements....................................... 7

5. Measures to address procyclicality ............................................................................. 14

6. Conclusion……………………………………............................................................ 17

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NTRODUCTION

Article 502 of Regulation (EU) 575/2013 of the European Parliament and of the

Council

requires the Commission to examine periodically whether risk-sensitive regulatory

requirements, as established in that Regulation and in Directive 2013/36/EU of the European

Parliament and of the Council

, create unintended procyclical effects by reinforcing the

endogenous relationship between the financial system and the real economy and thereby

amplifying the real economic cycle. The Commission is required to submit a proposal for

appropriate corrective measures, should such procyclical effects be found The Commission

report is the first one under Regulation (EU) 575/2013 and follows earlier and similar reports

on procyclicality of capital ratio requirements published in 2010 and 2012.

The Commission

reports of 2010 and 2012 emphasised that while there was only limited evidence of a

procyclical impact of capital ratio requirements on the wider economy, it was important to

have counter-cyclical measures in the prudential framework.

This Staff Working Document accompanies the third Commission report under Article 502 of

Regulation (EU) 575/2013 and presents more detailed evidence on whether capital ratio

requirements are procyclical and if so, whether they have an impact on the level of capital that

banks actually hold or desire to hold. This Staff Document also gives an overview of

measures to mitigate procyclicality of capital ratio requirements which are embedded in the

prevailing regulatory framework. The analysis draws upon a dedicated report by the European

Banking Authority (EBA), which encompasses contributions from the European Systemic

Risk Board (ESRB), the European Central Bank (ECB) and authorities from EU Member

States.

It further builds on a broader examination of the literature.

ACKGROUND

There is broad consensus among regulators and academics that the financial system is

inherently unstable and subject to risks which can have severe negative consequences for the

real economy once they materialise. This is borne out also by historical experience. The

global financial crisis, which broke out a decade ago, provided a stark reminder. To counter

that financial instability, financial regulation and macroprudential policy aim at limiting

systemic risk.

A key lesson of the crisis was that in several cases banking sectors were undercapitalised.

Even before the crisis, a risk-sensitive framework for regulatory capital had started to be

introduced to ensure suitable capital buffers would be in place. With the lessons from the

crisis in mind, imposing sufficiently high capital buffers, especially for banks, is generally

seen to increase banks' resilience, which may in turn reduce the probability of systemic

Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on

prudential requirements for credit institutions and investment firms and amending Regulation (EU)

No 648/2012 (OJ L 176, 27.6.2013, p. 1).

Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the

activity of credit institutions and the prudential supervision of credit institutions and investment firms,

amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (OJ L 176,

27.6.2013, p. 338).

SEC(2010)754, COM (2012) 400.

EBA Report under Article 502 CRR, issued on 22 December 2016 (EBA-Op-2016-24):

https://www.eba.europa.eu/documents/10180/1701905/Report+on+the+Cyclicality+of+Capital+Requir

ements+%28EBA-Op-2016-24%29.pdf

kom (2018) 0172 - Ingen titel

financial crises and their cost if they do occur.

On the other hand, higher buffers could entail

short-term costs in terms of limitations to credit growth to households and firms and possibly

act as a brake on economic growth. On balance, there are long-term benefits of moving

towards higher capital ratio levels. It would reduce the likelihood of asset fire-sales by banks

in periods of stress with negative consequences for the wider economy. Sufficiently high

capital ratio levels thus should promote more stable and durable growth.

But an unintended

procyclical bias stemming from capital ratio requirements would be a key externality of the

financial system which can cause financial stability risks and would therefore be of concern to

regulators.

Procyclicality of capital ratio requirements implies that capital ratio requirements become

looser in an upturn and tighter in a downturn, causing the amplification of fluctuations in the

economic cycle by the activities of the banking system. The degree of cyclical amplification

depends on the way in which banks respond to changes in required capital ratios as well as on

the relative strength of the transmission channels. A procyclical impact could be particularly

pronounced if capital ratio requirements are at very low levels, which potentially implies

sharp changes in balance sheet size when losses or gains materialise.

A number of explanatory factors have been brought forward to account for the inherent

procyclicality of financial regulation. These include information asymmetries between

borrowers and lenders, difficulties in measuring risks over the cycle, the nature of incentives

for financial sector agents, divergences in the maturity structure of assets and liabilities, and

the highly interconnected nature of the financial sector, which can exacerbate the transmission

of shocks. The specific role of risk-weighted bank capital ratio requirements makes them the

most likely identifiable source of procyclicality. As credit and market risk increase in a

downturn, minimum capital ratio requirements for banks will also increase to meet those

higher risks as the risk weight associated with each loan is related negatively to the

borrower’s credit quality. Banks may need to raise additional capital to meet these higher

requirements at a time when their capital resources are being eroded by losses. In such

Basel Committee on Banking Supervision (BCBS), (2010), "Basel III: A global regulatory framework

for more resilient banks and banking systems".

See Admati, A. (2016), "The Missed Opportunity and Challenge of Capital Regulation",

National

Institute Economic Review,

Vol 235, Issue 1, 2016, which points out that not all types of risky lending

are equally valuable, implying that near-term reduced lending may be partly beneficial. However, see

Perotti, E., L. Ratnovski and R. Vlahu (2011), "Capital Regulation and Tail Risk",

International

Journal of Central Banking,

Vol. 7 No. 4, December 2011, who, on theoretical considerations, argue

that higher capital buffers may in fact encourage risk taking as banks 'lever up' their capital by taking on

more risk. On the other hand, Begenau, J. (2016), "Capital Requirements, Risk Choice, and Liquidity

Provision in a Business Cycle Model", Harvard Business School Finance Working Paper No. 15-072,

argues that under certain conditions, depending on the nature and size of frictions, higher capital

requirements can lead to more lending in the long run.

This has long been recognised in the literature. See, for instance, Adrian, T. and H. Shin, (2010),

"Liquidity and Leverage",

Journal of Financial Intermediation,

Vol. 19 Issue 3, July 2010; Altman, E.,

and A. Saunders, (2001), "An analysis and critique of the BIS proposal on capital adequacy and

ratings", Journal of Banking and Finance, 25 (1); Basel Committee on Banking Supervision (BCBS),

(2010), "Basel III: A global regulatory framework for more resilient banks and banking systems";

Gordy, M. and B. Howells, (2006), "Procyclicality in Basel II: can we treat the disease without killing

the patient?",

Journal of Financial Intermediation,

Vol. 15; Repullo, R., J. Saurina and C. Trucharte,

(2010), "Mitigating the pro-cyclicality of Basel II",

Economic Policy,

25 (64).

Therefore, higher capital ratio levels imply a lower potential impact on balance sheet size when losses

or gains materialise, which in turn would limit the procyclical impact. In December 2017, the Basel

Committee reached an agreement on floors for capital requirements which has implications for banks

who use internal ratings based approaches as regards capital requirements for certain exposures, such as

residential real estate.

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circumstances, opportunities for raising capital could become scarce and costly.

This may

constrain banks' lending capacity to the economy, amplifying the downturn. Similarly, during

an economic upturn when defaults decrease, the reduction in risk will reduce capital ratio

requirements and might thus lead to increased lending, boosting the economy further. This

intrinsic procyclicality should be distinguished from the cyclicality of capital ratio

requirements stemming from the economic cycle.

The systemic dimension is of particular concern to regulators. Systemic risk can, arise if there

are correlated behaviours which compel banks to simultaneously sell similar assets in a crisis,

leading to an asset-price crash (endogenous risk). These mutually reinforcing interactions tend

to amplify business cycle fluctuations and can cause or exacerbate financial instability. In this

respect, the diversity of business models across the banking sector may mitigate such self-

reinforcing interactions.

In adjusting to increased capital ratio requirements, banks have a number of options.

First,

they can raise equity which potentially has the least procyclical impact. Second, they can

retain earnings, implying lower profits or cost reductions, and reduce dividend payments.

Depending on the degree of profitability and the stage of the cycle, this might have a

relatively benign impact on lending but might imply higher lending spreads. Third, they can

adjust assets with an impact on lending, for instance as loan portfolios are run down. Fourth,

they can reduce risk-weighted assets via some combination of shedding riskier loans in favour

of safer ones or by resorting more to internal models to calculate risk weights. In a period of

systemic stress a negative effect on the wider economy is more likely. In such a situation,

banks may have difficulty raising capital and/or may be reluctant to reduce dividend payments

to avoid stigmatisation from investors. They may therefore opt to deleverage in order to avoid

breaching capital requirements.

The prevailing framework for bank regulation which determines the response of financial

institutions reflects international agreements. In the Union, Regulation (EU) 575/2013 and

Directive 2013/36/EUCRD govern the implementation of the so-called Basel framework, a

comprehensive set of measures developed by the Basel Committee on Banking Supervision,

to strengthen the regulation, supervision and risk management of the banking sector. The

Basel III framework is the most recent version of the rules and is still in the process of being

fully implemented. It maintains the risk-based approach to capital ratio requirements

developed in the preceding Basel II framework. Compared to the first vintages of capital rules

(Basel I), the Basel II rules had established a closer alignment of the calculation of banks'

risk-weighted assets with actual risk. Riskier assets should therefore be backed by higher

capital allowances. In recognition of the fact that the risk-sensitive framework can be a

potential source of procyclicality, there are provisions in Regulation (EU) 575/2013 and

Gambacorta, L. and H. Shin, (2016), "Why bank capital matters for monetary policy",

Journal of

Financial Intermediation,

in press 2016, show that bank equity tends to be kept stable over time as

banks leverage up and down over the cycle mainly via adjusting debt issuance and/or the distribution of

retained earnings. On the sources of funding of credit institutions, see EBA (2017), Report on funding

plans

(https://www.eba.europa.eu/documents/10180/1720738/Report+on+Funding+Plans+-

+July+2017.pdf)

and

BCBS

(2017),

Basel

III

monitoring

report

(http://www.bis.org/bcbs/publ/d416.pdf).

The Study on the Impact of the Capital Requirements Regulation (CRR) on the access to finance for

business and long-term investments, prepared by LE Europe for the European Commission in May

2016, addresses the broader question of the impact of regulation on the economy:

https://ec.europa.eu/info/publications/160505-crr-study_en

Cohen, B., and M. Scatigna, (2016), "Banks and capital requirements: Channels of adjustment", Journal

of Banking and Finance, Vol 69, 2016.

kom (2018) 0172 - Ingen titel

Directive 2013/36/EU, consistent with the Basel framework, which aim at mitigating these

feedback loops. Several capital buffers have been introduced under this framework to ensure

that banks build up capital buffers outside periods of stress which can be drawn down as

losses are incurred. These include the Capital Conservation Buffer and the Countercyclical

Capital Buffer, which explicitly aim at increasing the resilience of the financial system

without altering its risk-based nature.

ETHODOLOGY

The pattern of a time series related to capital ratio requirements is considered to be cyclical if

it fluctuates inversely with aggregate real economic activity (the business cycle). Typically,

the correlation sign will be negative in that risk parameter levels and capital ratio

requirements go down in an upturn and move up in a downturn. Procyclicality will be

understood as the existence of evidence on amplifying effects on changes in capital ratio

requirements from feedback loops between the real economy and the financial system, in

particular if they are driven by internal risk measurement approaches differentiated by risk

category, exposure classes and types of institution.

The question of procyclicality of capital ratio requirements is in first instance an empirical

one. Recent literature surveys find limited and rather inconclusive evidence on the long-run

impact of changes in capital ratio requirements on the level or growth rate of bank lending,

even though negative near-term impacts are documented.

To shed further light on the issue,

the EBA report examines evidence for the Union with a narrower focus on the procyclical

impact of recent regulation on capital ratio requirements for banks. To that end, the EBA

report uses information available from public sources as well as dedicated bank-specific data

collected from National Competent Authorities

The categorisation of financial institutions is relevant to the extent that there are differences

across types of banks with respect to which regulation may induce procyclicality. In the Basel

II framework minimum capital ratio requirements are more risk-sensitive and tend to be more

cyclical than under Basel I. This is the result of the higher risk sensitivity of the current

framework, in particular as regards the calculation of capital ratio requirements using internal

models under internal ratings based (IRB) approaches. This basic characteristic has been

retained in the Basel III framework, implemented in EU law via Regulation (EU) 575/2013

and Directive 2013/36/EU. Depending on the range of model parameters estimated, one can

distinguish between so-called foundation IRB and advanced IRB approaches. The foundation

IRB approach uses internal models to assess the probability of default of certain exposures. In

the most elaborate versions of internal models used (advanced IRB approach), calculations of

the required capital allowances is done on the basis of banks' own probability of default

estimates as well as estimates of the exposure at default and loss given default. Banks which

have received permission to use the internal ratings based approach may permanently apply a

partial use of the standardised approach (e.g. for exposures to governments and central

banks). To the extent that probability of default and loss given default are time dependent, a

cyclical pattern of risk weights – and, by extension, of capital ratio requirements – is more

likely to be seen with banks that use an internal ratings based approach, rather than with banks

See, for instance, Martynova, N. (2015), "Effect of bank capital requirements on economic growth: a

survey", DNB Working Paper, No. 467 / March 2015. The study by LE Europe (see footnote 8), also

finds no clear evidence on a relationship between capital ratios and bank financing of infrastructure

projects.

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which rely on more standardised gauges of risk.

Hence, there is a presumption of a

procyclical bias especially for banks which heavily rely on internal ratings in terms of the

effect on overall leverage and lending to non-financial sectors.

Most of the data examined by EBA span the period 2008-2015, covering the global financial

crisis and its aftermath. This means that, to the extent possible, one would have to disentangle

any increases in capital ratio requirements due to the protracted downturn from increases due

to stricter requirements. In addition to aggregate statistics and survey data – including from

the ECB Bank Lending Survey– the EBA relies on a sample of 144 individual banks active in

13 Union and EEA countries and representing some 95% of the Union banking sector's total

assets. The broad sample includes banks with different scales of operation, ranging from

international systemic banks to ones that are active only domestically. It covers banks with

different business models, including retail and commercial banks, universal banks, as well as

a number of banks with more specialised activities, such as covered bond issuance or

investment banking. Around one quarter of the banks in the sample (38 institutions) are

categorised as large and international active (so-called Group 1 banks), with the remaining

106 categorised as small and/or only active on the domestic market (labelled Group 2 banks).

Most of the banks in the broad sample use the so-called standardised approach for gauging

credit and operational risk. Some of the detailed findings on risk categories and the

composition of minimum required bank capital in the EBA report are limited to banks that use

internal ratings and that account for the bulk of bank lending in the Union and the euro area.

In the EBA report, some more in-depth time series analyses are based on a consistent sample

of 41 banks from 8 Union Member States (Belgium, France, Germany, Ireland, Italy,

Luxembourg, Spain and the United Kingdom). To conclude, the statistical basis provided by

EBA is broad with a representative coverage, albeit not fully comprehensive.

Although the EBA data set is comparatively rich, a lack of granular data on the composition

of bank balance sheets hinders the identification of the various adjustment channels.

Confidentiality criteria are partly the reason for this. In addition, most of the data are on larger

banks who often undertake significant cross-border activities, while the behaviour of smaller

institutions might not be sufficiently captured. The econometric analysis is subject to a

number of additional caveats, such as the lack of data over a whole business or financial cycle

and other limitations in the coverage and breakdown of the figures. Moreover, the available

sample period does not span a full financial cycle and encompasses the recent global financial

crisis, where crisis-induced behavioural changes and policy interventions may well have

interacted with the shift to higher capital ratio requirements implied by Regulation (EU)

575/2013 and Directive 2013/36/EU. This may have distorted bank behaviour. There is no

simple solution to the problem of time coverage as the cyclicality of regulatory capital ratio

requirements in Regulation (EU) 575/2013 and Directive 2013/36/EU is the core concern of

this report, so it is no option to only focus on the period before the global crisis.

It is a challenging task to disentangle the exogenous effects on banks’ lending decisions from

those that may arise due to the risk-sensitive capital ratio requirements. This goes in particular

for identifying the impact of changes in bank capital on lending and the economy as bank

capital itself tends to respond to changes in bank lending and in the macroeconomic

environment. Hence, a large part of the variation in bank capital is likely to result from

disturbances to macroeconomic variables (such as economic activity or interest rates) as well

Cyclical patterns may also arise under the standardised approach. See, for instance, Danielson, J. et al.,

(2001), "An Academic Response to Basel II", LSE Financial Markets Group, Special Paper No. 130.

A bank is considered a Group 1 bank if its Tier 1 capital is above €3 billion and it is well diversified

and internationally active. All other banks are classified as Group 2 banks.

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as from changes in regulation.

It follows that there are caveats when analysing the

relationship between regulatory capital ratio requirements and the possible procyclical lending

of banks. First, several of the feedback loops between the real and financial spheres of the

economy can operate without a major contribution from the banking sector, for instance as

regards shocks to creditworthiness of agents in non-financial sectors. Second, changes in loan

demand could well be unrelated to capital ratio requirements, as could determinants of bank's

decisions to supply loans. The bank balance sheet channel need not be linear with respect to

capital ratio requirements to the extent that desired capital buffers above the regulatory

minimum (which has a bearing on the provision of credit) may well be determined by a host

of non-regulatory drivers. Also, the size of voluntary buffers will have a bearing on how

directly capital limits steer bank behaviour. Although there is some evidence that banks target

a certain additional buffer, they could use any extra capital over the required level to cover

any changes to the minimally required thresholds.

In order to address such caveats, the analysis in the EBA report is structured along various

complementary dimensions. It first presents an overview of the cyclical properties of overall

capital ratios and requirements. It then continues with micro-level evidence to examine

whether bank's capital ratio requirements mirror the development of the overall business cycle

and further examines whether capital ratio requirements contribute to the amplification of

business cycles. Similar approaches can be found in other studies pertinent to the subject.

SSESSING THE CYCLICALITY OF REGULATORY CAPITAL RATIO REQUIREMENTS

Overall capital adequacy ratio levels of Union banks have continuously increased since the

onset of the global financial crisis. The increase accelerated since 2014 with the application of

the capital ratio requirements laid down in Regulation (EU) 575/2013 and Directive

2013/36/EU. The significant increase in capital has been driven primarily by a rise in banks'

Common Equity Tier 1 capital ratio requirements. Capital ratios of banks using the internal

ratings based approach were the lowest on average. Group 2 banks had on average higher

Common Equity Tier 1 ratios than the large international banks in Group 1. According to data

gathered by the Bank for International Settlements (BIS), additional capital buffers also

increased, including those stemming from second pillar requirements imposed by supervisors

on individual banks in view of their risk profile.

The figures do not allow for a fully

consistent breakdown, mainly because in most cases the level of second pillar requirements is

not publicly disclosed. That said, it seems that in the wake of the crisis overall capital ratio

levels in the Union have increased faster than the required regulatory minimum ratios. This is

in line with findings for the United States and could be due to a preference of banks for

additional room for manoeuvre in their capital buffers in a period of uncertainty.

The increase in capital ratio levels of the Union banking sector appears to largely reflect a

combination of higher minimum capital ratio requirements and a tendency to retain voluntary

buffers above imposed minimum levels. The cyclicality of underlying internal rating based

risk parameters, notably probability of default and loss given default, has not been a

prominent driver. Somewhat surprisingly, these risk parameters are found to have remained

relatively stable over the sample period which covers a major economic downturn in most

Kanngiesser, D. et al., (2017), "Estimating the impact of shocks to bank capital in the euro area", ECB

WP 2077.

BCBS, (2017), Basel III monitoring report (http://www.bis.org/bcbs/publ/d416.pdf ).

Corbae, D. and P. D'Erasmo, (2014), "Capital Requirements in a Quantitative Model of Banking

Industry Dynamics", Federal Reserve Bank of Philadelphia Working Paper No. 14-13.

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Member States. The EBA report speculates that the limited observed procyclicality of the

risk-sensitive risk parameters could be explained by banks' active portfolio reshuffling

intended to keep capital ratio requirements stable over time. The evidence is discussed in

more detail below.

In contrast to the rise in mandatory and overall capital buffers, total risk-weighted asset ratios

of European banks declined from 2008 onwards, with some modest pick-up since 2014. Loan

portfolios mirrored this trend. In particular, loans from euro area-based banks to non-financial

corporations decreased in the aftermath of the global financial crisis as weak aggregate

demand weighed on the demand for credit. Some pick-up was only registered towards the end

of the sample period. The decrease in risk-weighted assets has been larger than the fall in the

exposures as defined for the leverage ratio, suggesting some rebalancing of bank portfolios.

The development of risk-weighted exposures was largely due to the trends in credit risk, the

most important subcategory.

Broken down by asset class, minimum capital ratio requirements increased the most for equity

exposures but decreased for securitisation exposures (which only accounts for a small fraction

of total credit risk exposure). The highest volatility in minimum required capital per exposure

was observed for particular subcategories of bank portfolios (such as securitisation, market

risk and equity exposures), which account for only a small share of the total balance sheet and

consequently only exert a muted impact on overall capital ratio requirements. By contrast, the

largest exposures existed with respect to the corporate and bank portfolios, followed by the

sovereign portfolios for which minimum required capital was the lowest. These categories

exhibited more stable parameters for minimum required capital.

The evolution of risk weights, other risk parameters (probability of default and loss given

default), exposures and leverage ratios adds perspective to the observed trends in bank

portfolios between end-2008 and 2015. During that period, the average risk weight for credit

risk exposure decreased somewhat until 2013 and only increased marginally thereafter.

Likewise, probability of default and loss given default parameters also did not show great

movements. The share of defaulted exposures was highest for corporate and retail portfolios

and was consistently lower for sovereign and bank portfolios with the probability of default

for non-defaulted exposures following an inverse pattern. For corporate and retail portfolios,

use of the internal ratings based approach has increased significantly for Group 1 banks, while

it decreased for Group 2 banks. The decline in average risk weights over 2008-2013, notably

for corporate and retail portfolios, may appear to be counterintuitive as that period covers the

most intense phase of the global financial crisis and the euro area sovereign debt crisis. It may

indicate a degree of stickiness of banks' risk weights under the internal ratings based approach

over the business cycle. This suggests that any upward pressure on risk parameters exerted by

the unfavourable general economic climate was more than compensated for by the pressure on

banks to reduce risk exposure and to deleverage, to boost capital ratio levels, or also to reduce

risk weights by exploiting the set-up of internal models.

It is not possible to disentangle

those effects because capital ratios are endogenous, influenced by monetary policy and credit

dynamics conditions, as well as by discretionary changes in broader economic policy. The full

range of possible interacting factors is not captured in most stylised and model-based

For the European banking sector in the aftermath of the crisis, Kanngieser, D. et al. (2017), use a VAR

model which suggest that banks boosted capital ratios mainly by reducing their relative exposure to

riskier assets and by adjusting lending to a larger extent, rather than by increase the level of capital and

reserves outright. On the dynamics in risks weights, total assets and the amount of capital, see also the

BCBS (2017) Basel III monitoring report. It shows a decrease in risk-weighted assets in Europe over

the crisis period.

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approaches, which typically assume that observed changes in risk weights are entirely driven

by changes in credit default probabilities. The treatment of non-performing loans also plays a

role. The migration of reported exposures from performing to non-performing may have

driven some of the observed actual patterns of portfolio allocations and need not have

impacted the profile of risk parameters.

Overall, the evolution of bank's risk parameters since end-2008 does not indicate strong

cyclical patterns, even in the midst of the crisis. The minimum required capital per exposure

has remained comparatively stable while average risk weights have mostly declined since

end-2008. Only up to a point could that mirror the impact of the use of internal models. It

could largely reflect a counterbalancing effect between the development of risk measures such

as probability of default or loss given default on the one hand and cyclical developments in

exposures on the other. In a downturn, the effect of a higher probability of default may be

offset by a reduction in exposures, when combined as inputs into the minimum required

capital. This highlights the role of portfolio shifts. In a recessionary period, more exposures

(typically riskier ones) move from performing to defaulted, with the exposures remaining in

the portfolio being the better ones. Hence, as banks attempt to improve their overall credit

quality and in particular curtail lending to riskier counterparties, average credit risk would

tend to improve and the probability of default would decrease. The financial crisis itself also

probably played a role to the extent that it induced reallocation of assets, irrespective of

changes in the underlying risk parameters per se. The leverage ratio increased, driven by

capital increases which more than offset the overall increase in the exposure measure.

Banks

may have targeted a higher amount of assets eligible as collateral in central bank liquidity

operations to improve their liquidity position and to be able to benefit from cheap central bank

funding. In the absence of the crisis, the minimum required capital might have been more

cyclical. Thus, while there appears to be limited cyclicality in the overall aggregate ratios,

such dynamics might in fact be procyclical to the extent that borrowers to whom banks do no

longer lend have difficulty finding alternative financing.

The EBA report extends the analysis on the basis of aggregate capital data and risk parameters

by an econometric analysis for a broad sample of banks, mostly using internal ratings

approaches, spanning 15 semi-annual observations from the second half of 2008 to the second

half of 2015. The regression approach used aims at capturing statistical linkages between

banking and macroeconomic variables. The business cycle is represented through different

country-specific variables capturing the dynamics of the real economy.

A first set of regressions examines possible drivers of cyclicality of minimum required capital

broken down by the contributions of credit risk, market risk and operational risk. Aggregate

bank variables display a reaction to values of industrial production with a lag of two periods

and a contemporaneous measure of economic sentiment. The statistically significant results

imply a negative relationship, meaning that minimum required capital tends to decrease as

economic conditions improve and vice versa. This result holds for total minimum required

capital as well as the constituent subcategories. A specific dummy variable was introduced to

capture the possible impact of the introduction of Basel III rules as mirrored in Regulation

(EU) 575/2013 and Directive 2013/36/EU, with potential shifts in the mean level of

regulatory required minimum capital. The effect of Basel III did mostly not prove to be

BCBS, (2017), Basel III monitoring report (http://www.bis.org/bcbs/publ/d416.pdf).

These include industrial production – which is thought to track real economic activity better than real

GDP does; an industrial production index for the euro area, domestic unemployment rates; a forward

looking indicator of overall economic sentiment (ESI), and consumer confidence indices.

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statistically significant and thus does not signal a pronounced one-off shift or procyclical

impact in capital ratio requirements due to the introduction of new regulations.

From various alternative regression specifications, it appears that changes in exposures,

notably exposure at default, rather than estimated overall risk parameters, drive cyclical

patterns in bank capital. That finding strongly confirms the role of portfolio rebalancing as a

prime driver of the observed trends in assets and risk weights. There is no difference between

risk-based and standardised approaches in this respect. That said, a smaller subset of the data

allows to identify the contributions from so-called Credit Conversion Factors (which notably

are used to capture off-balance sheet items) and Credit Risk Mitigants (for instance used to

assess the impact of guarantees and credit derivatives) and suggests that their impact mainly

accounts for the cyclical response of exposure at default values to the real economy. This

could well be due to the fact that borrowers are likely to draw down unused credit lines

(which are mirrored in Credit Conversion Factors) as economic conditions worsen, while the

inherent cyclicality of collateral values, margins and haircuts reflected in Credit Risk

Mitigants would tend to drive up exposures. Hence, any cyclical dynamics of transmission

channels from the regulatory framework to bank capital would not necessarily be due to

variations in risk parameters. Also, the empirical evidence does not seem to support the notion

that banks which use internal ratings based approaches are more prone to cyclical dynamics in

their capital ratio levels.

These findings are broadly supported from a portfolio-level analysis, but with some

qualifications. For reasons of coverage, the portfolio data include regressions for exposures of

banks using internal ratings approaches for minimum required capital based on credit risk as

well as other risk factors for four main portfolios: bank, corporate, retail and sovereign

exposures. In line with the results at the bank level, minimum required capital and risk

measures would be expected to increase during downturns, and thus be negatively correlated

with coincident business cycle indicators. For bank and corporate portfolios, minimum

required capital was found to correlate negatively with economic sentiment and industrial

production indicators. This confirms the expectation that these portfolios would be most

directly linked to the business cycle. For the retail portfolio, a correlation was found with the

lagged unemployment rate as an alternative business cycle indicator. Again, this seems to be

in line with prior expectation, to the extent that retail lending should be mirroring more

closely conditions in the labour market which respond to the overall economic cycle with

some delay. For the sovereign portfolio, no clear statistical relationship did emerge. This

could be due to the smaller number of observations for sovereign portfolio items, but may

also be due to the rather idiosyncratic pattern of public debt management and the role that

fiscal policy often tries to play in dampening cyclical swings (albeit with variable lags).

Estimates of how portfolio-specific capital ratio requirements are impacted by risk factors

broadly confirm the transmission channel from the latter to capital ratio requirements. By

contrast, further regressions of portfolio-specific risk factors (probability of default, loss given

default, exposure at default, as well as risk weights) on business cycle indicators do not give

conclusive results. Measures of probability of default and loss given default mostly appear to

be unrelated to any of the business cycle indicators. For bank and corporate portfolios, the

link to business cycle indicators is stronger for exposure at default. Similar results emerge for

risk weights. This is line with the bank-level results, which indicate that the impact of the

business cycle is strongest on exposures rather than on risk weights. In all, these results

suggest some procyclical effect of the macro economy on banks variables, notably on

minimum required capital. That said, the reported coefficient values are, while still

statistically significant, moderate in absolute size. Therefore, the strength of any feedback

effects would appear to be limited. Model specifications including additional portfolio-

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specific control variables mostly yield insignificant coefficients. This may well be due to the

difficulty of controlling for loan demand effects and portfolio reshuffling effects due to shifts

to less capital-intensive exposures, which may prevent any actual procyclical effects from

becoming visible. In addition, some evidence of a structural break in the regulatory regime

due to the transition to the Basel III framework imposed through Regulation (EU) 575/2013

and Directive 2013/36/EU. This transition would feed into the interaction between bank

capital and the real economy. Even so, it is difficult to distinguish level effects from a more

lasting procyclical impact of the regulatory requirements introduced by Regulation (EU)

575/2013 and Directive 2013/36/EU, also in view of the short observation period since its

introduction.

The results from the statistical analyses in the EBA report have to be treated with some degree

of caution. This is partially due to the limited sample size (when performed on more detailed

breakdowns of the data). They may reflect the specific period examined, which was

characterised by strong swings in real activity, substantial crisis-induced financial losses,

public capital injections and a strong regulatory drive to increase capital buffers. The high

level of aggregation of the bank level data used may also imply a lack of empirical precision.

However, the findings are broadly consistent with those obtained from the evidence on

aggregate capital ratios. They indicate weak cyclical patterns in bank capital ratio levels. This

also resonates with findings in the academic literature that capital buffers above minimum

requirements tend to decrease when business activity goes up, implying higher risk-taking

during economic upswings, whereas lending is curtailed in downturns.

A further approach taken in the EBA report combines results from the ECB's Bank Lending

Survey and Survey on Access to Finance of Enterprises (SAFE) with micro-econometric

evidence from the EBA bank panel data. The qualitative survey-based information reveals

clear trends over the last decade. Credit standards tightened markedly at the onset of the

global financial crisis, followed by a slump in credit demand. Credit standards overall were

subsequently eased, especially since end-2014, while loan demand recovered also. As to the

perception of how capital ratio requirements might contribute to the amplification of business

cycles, since 2011 the ECB Bank Lending Survey has been asking banks about the effects of

(upcoming) specific capital regulations. Respondents generally agree that there are links

between banks' capital management policies and their loan granting process and that

regulatory provisions play an important role. However, survey results do not allow for a clear

distinction between loan supply effects due to the adoption of Regulation (EU)

575/2013/Directive 2013/36/EU, crisis-related effects, and other determinants of credit

See, for example, Ayuso, J., et al., (2004), "Are capital buffers pro-cyclical?: Evidence from Spanish

panel data", Journal of Financial Intermediation, Vol. 13 Issue 2; Bikker, J., and P. Metzemakers,

(2004), "Bank provisioning behaviour and procyclicality", Journal of International Financial Markets,

Institutions and Money, Vol. 15 Issue 2; Lindquist, K., (2004), "Banks’ buffer capital: how important is

risk", Journal of International Money and Finance, Vol. 23 Issue 3; Jokipii, T., and A. Milne, (2008),

"The cyclical behaviour of European bank capital buffers", Journal of Banking and Finance, Vol. 32

Issue 8; and Stolz, S., and M. Wedow, (2011), "Banks’ regulatory capital buffer and the business cycle:

Evidence for Germany", Journal of Financial Stability, Vol. 7 Issue 2. These results do not lend support

to a different suggestion highlighted in different strand of the literature, which pointed to the possibility

that in a stronger risk-based regulatory framework banks may actually decide to insure against

perceived more cyclical minimum required capital by letting capital buffers move with the cycle; being

higher in upturns and vice versa. On this, see Heid, F., (2007), "The cyclical effects of the Basel II

capital requirements", Journal of Banking and Finance, Vol. 31 Issue 12; Zhu (2008), Jokivuolle, E., et

al., (2009), "Credit Allocation, Capital Requirements and Procyclicality", Bank of Finland Research

Discussion Paper No. 23/2009; and Repullo, R., and J. Suarez, (2009), "The Procyclical Effects of Bank

Capital Regulation", European Banking Center Discussion Paper No. 2010-05S.

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dynamics. Consistently respondents see 'expectations of general economic activity' and a host

of more specific supply and demand factors as more important in affecting cyclicality in loan

exposures than regulatory capital ratio requirements. Such drivers include the risk appetite of

banks, the outcome of stress tests, specific Pillar II requirements, cost of funding, interest

rates, market confidence, and perceived growth opportunities. The treatment of derivatives,

impairments, write-offs of loans could be a specific relevant feedback mechanism. Write-offs

tend to be more cyclical than regulatory capital ratio requirements for performing loans. In

fact, reclassification of overdue loans could lead to re-assessments of risk parameters which

could induce feedback effects on lending.

The SAFE survey provides additional qualitative information on enterprise loans to the Bank

Lending Survey data. The SAFE data were fed into purpose-built ECB models to identify the

impact of a credit supply shock on loan growth.

The model results broadly confirm the

findings from the BLS as regards the time profile for access to finance. Credit supply was

very tight during the acute phase of the global financial crisis and the sovereign debt crisis,

and has since improved considerably on the back of gradual economic conditions and

monetary policy easing. However, the improvement in access to bank financing initially was

mostly for large firms, whereas SMEs and in particular small firms only benefitted from

improved access to finance as the recovery firmed. The result of simulations in a Dynamic

Stochastic General Equilibrium economic model with a capital-constrained banking sector

and calibrated to the development in internal ratings based risk weights for a corporate

portfolio, give some support to the notion of a stronger amplification of the business cycle

under a regulatory regime where capital ratio requirements vary over time with borrower

default probabilities.

The main feedback mechanism in the model works through banks

increasing their capital buffers in response to unexpected losses.

The SAFE survey data, supported by modelling approaches, thus indicate that the regulatory

requirements in Regulation (EU) 575/2013 and Directive 2013/36/EU may have had some

procyclical impact. Any such effect is however difficult to disentangle from other factors and

in all it seems as if since 2008 crisis-related effects have been a major force in shaping bank

credit supply. It must be emphasised that the impact of one-off increases in the capital buffer

due to recapitalisation needs

and increases in the required capital ratio levels in view of new

regulation is a different phenomenon from the procyclicality of existing requirements. Recent

years witnessed the transition towards Basel III minimum requirements, which is due to be

completed by 2019. Banks responded to higher imposed minimum capital ratio levels by a

shift towards higher actual regulatory capital ratio levels. Shortfalls were reduced and while

the statistics do not allow for a clear calculation of the level of voluntary additional capital

See: Altavilla, C., et al., G. (2015), “Loan supply, credit markets and the euro area financial crisis”,

ECB Working paper, No.1861; Darracq-Paries, M., and R. De Santis, (2015), "A non-standard

monetary policy shock: The ECB's 3-year LTROs and the shift in credit supply", Journal of

International Money and Finance, Vol. 54; Hempell, H., and C. Kok, (2010), “The impact of supply

constraints on bank lending in the euro area – credit induced crunching”, ECB Working Paper No.

1262.

See Darracq Pariès, M., et al. (2011), “Macroeconomic propagation under different regulatory regimes:

An estimated DSGE model for the euro area”, International Journal of Central Banking, Vol. 7.

For recapitalisations see EBA, 9 Feb 2012:

http://www.eba.europa.eu/documents/10180/587401/Press-

release-EBA-9-02-2012_1.pdf.

See BCBS (2017) Basel III monitoring report on the marked reduction

in reported shortfalls in capital among European reporting banks. Because requirements under the

second pillar are mostly non-disclosed it is not possible to exactly compute the difference between the

actual level of buffers and the required minimum level across all categories.

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reserves, it is likely that voluntary buffers above the minimum imposed have increased.

The

size of the imposed structural increase in capital ratio requirements is such that the aggregate

impact on bank behaviour of this one-off adjustment probably dominates any cyclical

impulses from endogenous adjustments to capital ratio requirements.

Adjusting to new regulatory constraints requires capital and liquidity planning by the

institutions affected. This can work through (a combination of) the various adjustments

channels: raising equity, reducing dividend payments, retaining earnings, asset side

adjustments and changes in the calculation of risk weights. The overarching concerns is that

in periods of systemic stress banks would deleverage and curtail lending to the economy, in

view of difficulties with raising capital and a possible reluctance to curtail dividend payments.

Empirically, it is difficult to disentangle the different transmission channels, as only the

overall net impact on bank behaviour is observed. As argued above, over the period examined

one-off adjustments rather than a procyclical response are likely to have been the dominant

phenomenon. The period since introduction of Regulation (EU) 575/2013/Directive

2013/36/EU has been short compared to the typical duration of a financial cycle, which

militates against drawing strong conclusions. Yet the macro and micro data and the

simulations in the EBA report, as well as data from the Bank for International Settlements on

the implementation of the Basel III framework, supplemented with reporting by EBA on the

funding sources of banks, confirm the role of portfolio shifts in the adjustment process. Banks

tend to adjust their portfolios by altering the composition rather than the volume of loans and

other assets, for example by substituting towards lower risk weighted assets. This is consistent

with a resulting drag on credit to the real economy.

In international comparison, European

banks had relatively weaker profit ratios to fund adjustments. The extent of the adjustment

depends on the extent to which banks’ actual capital ratios differ from their revised target.

The pattern emerging is consistent with the difficulties in access to finance observed across

Union Member States. They were the most pronounced in countries hardest hit by the

financial crisis and are noted especially for the financing of small and medium-sized

enterprises – a source of particular concern in terms of holding back the recovery.

Several

studies cite evidence of decreases in loan growth in the short run associated with the

imposition of higher capital ratio levels between 2009 and 2012 and confirm that portfolio

shifts within banks appear to have played a large role in adjusting to changes in the regulatory

requirements.

This notwithstanding, it appears that the structural adjustment to higher

In the study by LE Europe (see footnote 8), stakeholder groups surveyed shared the view that the

recapitalisation requirements in CRR/CRD have increased the resilience of the European banking sector

even though respondents were more critical of the additional supervisory capital requirements

stemming from supervisory stress tests (Pillar II add-ons), and macro prudential buffers.

On this, see for instance: BCBS (2017) Basel III monitoring report; and EBA (2017) Report on funding

plans.

See, for instance, Francis, W., and M. Osborne, (2012), "Capital requirements and bank behavior in the

UK: Are there lessons for international capital standards?", Journal of Banking and Finance, Vol 39,

2012. They find, on the basis of UK evidence largely preceding the global financial crisis that banks

tended to minimise the costs of complying with capital requirements by adjusting lower quality capital

and altering the average risk weights of their portfolios.

European Semester 2016 Thematic factsheet – Small and medium sized enterprises' access to finance:

https://ec.europa.eu/info/files/european-semester-thematic-factsheet-small-and-medium-sized-

enterprises-access-finance-2016_en

See Maurin, L., and M. Toivanen, (2012), "Risk, Capital Buffer and Bank Lending: A Granular

Approach to the Adjustment of Euro Area Banks", ECB Working Paper No. 1499; Cohen, B., and M.

Scatigna, (2016), "Banks and capital requirements: Channels of adjustment", Journal of Banking and

Finance, Vol 69, Mesonnier, J., and A. Monks, (2014), “Did the EBA capital exercise cause a credit

kom (2018) 0172 - Ingen titel

capital ratios for banks in the wake of the crisis has not been a separate source of major credit

retrenchment in the Union on top of other determinants of loan demand and supply. While

this could imply some procyclicality of the adjustment for corporate loans (especially for

SMEs which have less access to internal funding than large corporations do), such a response

is difficult to be separately identified in the data.

To sum up, the evidence is mixed and the experience is too short or limited to draw firm

conclusions on a possible clear procyclical impact of the regulatory framework laid down in

Regulation (EU) 575/2013 and Directive 2013/36/EU. This concerns in particular the impact

of buffer requirements on credit intermediation. Moreover, the experience is too short with

reference to the duration of a typical financial cycle to assess the effect of specific

requirements which are novel to the framework. This is, for instance, the case for the

countercyclical capital buffer. If not well calibrated and timely activated and released, it might

not achieve its purpose of bolstering resilience. At present, in only a few cases have

countercyclical buffers been activated or are in place with non-zero levels. To date, there is

also no significant experience with releasing them when the cycle has turned. From a

somewhat broader perspective, leverage requirements and the establishment of the Banking

Union may also be relevant. Indeed, resolution through bail in of leveraged institutions could

induce portfolio adjustments. Yet the experience with the leverage requirements has been too

short to muster sufficient empirical evidence on any procyclical effects.

EASURES TO ADDRESS PROCYCLICALITY

In 2013, the Union adopted

Regulation no 575/2013 and Directive 2013/36/EU.

November 2016, the Commission adopted a proposal on amendments to the capital

requirement regulations to incorporate the remaining elements of the regulatory framework

agreed within the Basel Committee on Banking Supervision (BCBS) to improve banks'

lending capacity to support the Union’s economy and to further facilitate the role of banks in

achieving deeper and more liquid Union capital markets.

On 20 September 2017 the

Commission published a proposal on the review of the Union system of financial supervision,

with a number of further proposed targeted improvements. The Commission advocated

targeted adjustments to the composition and organisation of the European Systemic Risk

Board and its coordination with Union bodies and institutions. The Commission's review has

shown that overall the macro-prudential toolkit is broadly effective and is able to address

financial stability risks.

The rules laid down in Regulation (EU) 575/2013 and Directive 2013/36/EU incorporate a

number of measures that may mitigate procyclicality in bank lending: higher capital ratio

requirements, countercyclical and capital conservation buffers, the introduction of a leverage

ratio, and reduced dependency on credit rating agencies for prudential requirements and stress

tests. To the extent that the combination of measures is successful in bolstering the resilience

crunch in Euro area?”, Banque de France Working Paper No. 491; Aiyar, S., et al., (2012), "How does

credit supply respond to monetary policy and bank minimum capital requirements?", Bank of England

WP 508. See also the LE Europe study, see footnote 8, which finds larger effects on bank lending flows

for banks with smaller capital cushions, in line with findings of Buch, C., and E. Prieto, (2014), "Do

Better Capitalized Banks Lend Less? Long-Run Panel Evidence from Germany", International Finance,

Vol. 17 Issue 1.

http://europa.eu/rapid/press-release_MEMO-16-3840_en.htm.

http://europa.eu/rapid/press-release_MEMO-17-3322_en.htm.

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of the financial sector, it may also help in mitigating the financial cycle and thus dampening

cyclical feedbacks.

5.1 Application of the capital ratio requirements laid down in Regulation

(EU) 575/2013 and Directive 2013/36/EU

As de-leveraging of credit in international banks in response to regulatory requirements set by

national supervisors may occur outside home jurisdictions, the full implementation of the

single rule book should reduce regulatory arbitrage. In particular, it might mitigate procyclical

effects of ring-fencing of capital and asymmetric de-leveraging in "host countries", that is

excessive credit retrenchment by internationally active banks in countries outside their home

jurisdiction. That is supported by the different pillars of the Banking Union, comprising

common resolution and deposit insurance provisions.

5.2

Capital Conservation Buffer and Countercyclical Capital Buffer

One key regulatory response to the perceived procyclicality of bank lending is the

introduction of a Capital Conservation Buffer and a Countercyclical Capital Buffer. These

extra buffers, built up over good economic times, can be released in an economic downturn to

enable banks to absorb their losses in an orderly way that does not lead to costly increases in

the price of credit, which can aggravate recession. They should mitigate both the existing lack

of responsiveness of regulatory requirements to risk build-up at the macro level and their

cyclicality. Since dynamics can be very different across different markets, the buffers are

determined on a national base. Common guidance for setting countercyclical capital buffer

rates has been developed by the European Systemic Risk Board.

As many Member States are still recovering from the recessionary shock of the global

financial crisis, only in few of them do Countercyclical Capital Buffer rates currently exceed

0%. Similarly, Capital Conservation Buffers have been built up, but to date there is no

experience in the Union with releasing such buffers.

In addition, as regards sectoral financial

stability risks related, for instance, to real estate, the Countercyclical Capital Buffer affects all

corporate and retail exposures and can currently not be targeted to sectoral exposures. In view

of this, reflections are ongoing in Basel and in the Union on the merits of introducing sector-

specific buffers to address the cyclical nature of some specific risks and to avoid some of the

inaction bias inherent to the broad scope of the Countercyclical Capital Buffer.

5.3

Risk weights for specific exposures and other supervisory measures

The current rules foresee specific macro-prudential measures, for instance in the form of

requirements on risk weights, to counter risks from specific exposures, such as real estate. In

particular, under Article 124 of Regulation (EU) 575/2013 competent authorities may set a

higher risk weight or stricter criteria on exposures secured by immovable property on the

basis of financial stability considerations. Similarly, Article 164 of Regulation (EU) 575/2013

allows competent authorities to set higher minimum values for exposure weighted loss given

Recommendation (ESRB/2014/1).

To date, only the UK announced a decrease in the Countercyclical Capital Buffer rate, in July 2016 to

0%. The rate was announced to be set 0.5% in March 2016, but it would have entered into force only in

March 2017.

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default for exposures secured by immovable property in their territory on the basis of

financial stability considerations. Article 458 of Regulation (EU) 575/2013 allows authorities

to adjust risk weights for targeting asset bubbles in the residential or commercial property

sector or to take measures such as adjusting the level of the own funds or the level of the

Capital Conservation Buffer, with a bearing on the capital base of banks. However, national

flexibility measures under Article 458 can only be applied if other macroprudential tools laid

down in Regulation (EU) 575/2013 and Directive 2013/36/EU cannot adequately address the

risk identified.

The EU regulatory framework comprises further measures which can mitigate the impact of

cyclical risks on banks. These include provisions in Articles 181 and 182 of Regulation (EU)

575/2013 on risk parameters associated with rating grades or pools, which require banks to

use estimates that are appropriate for an economic downturn if those are more conservative

than the long-run average. This is in the spirit of recommendations by the Basel Committee

on Banking Supervision for banks using internal ratings models to adopt a through-the-cycle

approach in calculating capital ratio requirements for credit risk. Such an approach would

dampen changes in required capital ratio level in response to changes in cyclical conditions.

Moreover, as regards institution-specific second pillar capital ratio requirements, supervisory

authorities can take into account cyclical risks to enhance the resilience of specific

institutions.

In addition, the implementation of other regulatory requirements have a bearing on mandatory

capital levels, for example, the banking book standards (IRRBB) and IFRS 9 accounting

standards.

The EU Supervisory Review and Evaluation Process may impact capital

requirements as do resolution provisions and loss absorbency requirements such as the

Minimum Requirement for own funds and Eligible Liabilities (MREL) and the total loss-

absorbing capacity thresholds for global systemically important banks.

5.4

Leverage ratio

The Leverage Ratio is an additional non risk-based capital requirement conceived as a

credible supplementary measure to the risk-based capital ratio requirements. In the Union, the

Leverage Ratio is being implemented in line with Basel III requirements, meaning that the

Leverage Ratio is calculated by dividing Tier 1 capital by the bank's average total

consolidated assets (sum of the exposures of all assets and non-balance sheet items), the banks

being expected to maintain a leverage ratio in excess of 3%. It would help to limit excessive

bank lending during the upswing of an economic cycle when banks have momentum to

expand balance sheets without an appropriate increase in capital.

The theoretical and empirical literature underlines the link between procyclical leverage and

financial instability. Empirically, banking sector leverage has been procyclical at an aggregate

level in almost all Union Member States, tending to fall in credit booms and rising in

downturns. A static leverage ratio limit would therefore address the procyclicality of banking

leverage during an upturn. Furthermore, it would operate as a backstop to the procyclicality of

risk-weighted capital ratio requirements. Indeed, it ensures that capital moves in proportion

with total exposure, while aggregate risk weights and risk-weighted capital requirement can

vary over time, according to the different phases of the cycle.

On the potential procyclical impact of IFRS 9 and how to address it see European Systemic Risk Board,

Financial stability implications of IFRS 9, July 2017,

https://www.esrb.europa.eu/pub/pdf/reports/20170717_fin_stab_imp_IFRS_9.en.pdf.

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5.5

Credit ratings

Credit ratings, obtained through specific credit rating agencies or internal rating models, also

play an important role in the determination of the actual capital ratio level of banks. External

ratings are closely correlated with the economic cycle, implying that capital ratio

requirements linked to external ratings will also follow a cyclical pattern, at least at the level

of individual exposures. In view of this, Regulation (EU) 575/2013 encourages the use of

internal ratings and strengthens provisions on how external ratings can be used.

For banks

using an internal ratings based approach, it requires independent risk assessment capability

and creates incentives to better manage credit risk. A through-the-cycle approach could help

smooth the impact on capital ratio requirements.

5.6

Stress tests

Stress test can be seen as another, albeit indirect, instrument to help avoid undue procyclical

responses of credit institutions to meet capital ratio requirements during periods of financial

stress. In the aftermath of the crisis, micro-prudential stress tests were used promptly to assess

the capital needs of individual banks. Such stress tests are helpful in informing how buffers

can be set, also above minimum requirements. The supervisory review and evaluation process

allows the results of stress tests to be used to devise supervisory measures, including capital

ratio requirements. However, they have significant limitations in the face of macro-prudential

policy concerns. The static balance-sheet approach is not well suited to stress-testing exercises

that run over a longer horizon of several years. In practice, banks can react to adverse

conditions by deleveraging, which in turn would have significantly different macro-financial

consequences affecting the economic environment. To exploit fully the potential of stress

tests, banks therefore have to take into account systemic risk associated with common shocks

to the financial system. This means assessing capital ratio requirements and macro-prudential

policy in a consistent manner, taking into account interactions within the banking sector as

well as interactions with the financial and non-financial sectors and the real economy.

ONCLUSION

While a procyclical impetus from capital ratio requirements is widely acknowledged in the

literature as a potential source of risk, the empirical evidence is not conclusive as regards its

actual strength for banks in the Union. There is no empirical evidence of a strong procyclical

bias of the current framework which would affect the non-financial sector in the Union

economy. This inconclusiveness may be driven by the available data not covering an entire

cycle, the lack of more granular data that would allow for distinguishing the behaviour of

different types of banks, the challenge to control for portfolio rebalancing effects, the

difficulty to disentangle loan supply and demand effects, and the difficulty to disentangle the

At the international level, in October 2010 the Financial Stability Board (FSB) issued principles to

reduce authorities’ and financial institutions’ reliance on CRA ratings (see

http://www.fsb.org/wp-

content/uploads/r_101027.pdf?page_moved=1).

The ECB is exploring so-called macro-prudential stress tests to incorporate the systemic risk dimension.

See: Dees, S., et al., (2017), "STAMP€: Stress-Test Analytics for Macroprudential Purposes in the euro

area",

www.ecb.europa.eu/pub/pdf/other/stampe201702.en.pdf.

kom (2018) 0172 - Ingen titel

impact of other post-crisis reforms and extraordinary policy measures throughout the sample

period.

Against the background of the weak evidence on the existence of procyclical effects due to

the rules laid down in Directive 2013/36/EU and Regulation (EU) 575/2013, there is no

reason at this juncture to propose significant alterations to the prevailing regulatory

framework for bank capital. The higher capital ratios achieved in recent years by construction

imply that the procyclical impact of a given loss will be weaker. The Union financial

regulatory framework has various tools at its disposal to deal with the impact of any

procyclical effects. These include the capital conservation buffer, the countercyclical capital

buffer, the leverage ratio, adjustments to risk weights for specific exposures and other

supervisory measures.

Looking ahead, the impact of the Union regulatory capital ratio requirements on the economic

cycle should be monitored regularly and the potential impact, effectiveness and efficiency of

counter-cyclical instruments should be further analysed. It will be important to gather

evidence on a continuous basis of any procyclical bias stemming from capital ratio

requirements becoming stronger. Concrete proposals to change the current set-up should be

based on such evidence becoming available to the greatest extent possible.