Minutes of the CNB Bank Board meeting on financial stability issues on 27 May 2021
Present at the meeting: Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Vojtěch Benda, Oldřich Dědek, Tomáš Holub, Aleš Michl.
The meeting opened with a presentation given by the Financial Stability Department on the main conclusions of Financial Stability Report 2020/2021. The presentation focused mainly on the position of the Czech economy in the financial cycle, risks to the domestic financial sector going forward, the resilience of the banking sector, regulatory changes in the macroprudential policy area, and risks associated with mortgage lending. The Bank Board first discussed the countercyclical buffer (CCyB) rate and the capital buffers needed to cover the usual risks and the risks linked with the receding pandemic. It then dealt in detail with the mortgage market and residential property market, and possible changes to macroprudential tools targeted at risks associated with mortgage lending.
The part of the Financial Stability Department’s presentation on the CCyB emphasised that, according to the aggregate financial cycle indicator and other indicators, the domestic economy had returned to a moderately expansionary phase of the financial cycle in the second half of last year. Despite the adverse economic situation, the cyclical risks accepted in the pre-pandemic expansionary phase of the cycle had not materialised significantly in the banking sector. They remained elevated. It was meanwhile highly likely that the domestic economy had now come through the acute phase of the economic and credit downturn. The taking on of new risks in bank balance sheets was intensifying due to the evolution of conditions in the household sector against a backdrop of favourable financial conditions. The methods used by the Financial Stability Department as a guide to setting the CCyB rate implied a rate of 1.75%. Despite the persisting uncertainty about the future course of the pandemic, the Financial Stability Department therefore recommended that the Bank Board increase the CCyB rate to the standard 1% level covering the usual level of risks with effect from 1 July 2022.
In the following discussion, the board members agreed that the financial sector had increased its resilience over the last two quarters. The recession that the economy had been through had not been a classical cyclical one. Its impact on the financial sector’s soundness and performance had been substantially smaller than expected last year. In the discussion, a majority of the board members supported the proposal to increase the CCyB rate to 1%. There was a consensus that, given their current capitalisation, banks had substantial lending capacity and that raising the CCyB rate would not create any credit supply constraints. The CCyB rate increase would not take effect for one year, so the decision had virtually no potential adverse impacts. Were the economic situation to worsen again, for example due to another wave of the pandemic, the Bank Board could flexibly rescind the announced CCyB rate increase or release the buffer immediately and fully. However, one of the board members expressed a preference for leaving the CCyB rate at 0.5%, arguing that there were persisting substantial uncertainties in the economy and it would therefore be more appropriate to wait for convincing signals of a robust economic recovery before increasing the CCyB rate to 1%. Another board member pointed to the fact that the rapid credit growth pertained solely to the housing loan segment, while growth in loans to non-financial corporations was still negative. In such a situation, it was appropriate to be cautious about raising the CCyB rate.
One of the major factors underlying the need to maintain a positive CCyB rate was a long-running decline in risk weights in banks that use internal ratings-based (IRB) approaches to determine their capital requirements. This decline primarily concerned exposures secured by residential property. The opinion was presented that the sectoral systemic risk buffer could be a more appropriate tool for dealing with this risk than the CCyB. It would deliver a targeted increase in the capital requirements for IRB banks with a large share of mortgage loans in total loans. The Financial Stability Department confirmed that it would be possible to use this tool in the Czech Republic, but only after the transposition of CRD V into Czech law. The relevant legislative proposal was currently at an advanced stage of debate in the Chamber of Deputies. If the CNB decided to use the sectoral systemic risk buffer, it would be necessary to revise the CCyB rate-setting framework to ensure that the relevant risk was not double counted. The Financial Stability Department also said that, in light of the favourable trend in mortgage portfolio quality, the decline in risk weights would probably continue in future years and could gradually come into potential conflict with the output floor to be phased in by 2027. The CNB’s microprudential supervision would continue to pay heightened attention to this risk. However, it was not appropriate at present to consider establishing a floor for risk weights as the supervisory and macroprudential authorities in some other EU countries had done.
The board members also discussed macroprudential and monetary policy coordination. In support of increasing the CCyB rate, it was said that macroprudential policy and monetary policy would remain well aligned if a CCyB rate increase was agreed, not only in terms of the settings of policy instruments, but also as regards communication of their likely paths. The prevailing opinion was that, as a recession phase recedes, it is natural to start normalising macroprudential policy rather earlier than monetary policy. This is mainly because changes to macroprudential tools usually begin to take effect with a lag, whereas changes to monetary policy do so immediately. As with the sharp reduction of the CCyB rate at the start of the pandemic, an increase now would act primarily as a signal.
The situation in the non-bank financial institutions sector was also presented and discussed. According to stress tests, the insurance sector remained resilient to risks and the capital buffer of pension management companies had increased, partly due to regulatory changes. Part of the Financial Stability Department’s presentation was also devoted to balance sheet liquidity in the financial sector. Liquidity stress tests and analytical indicators were showing that banks, insurance companies and funds were more resilient to liquidity risk than they had been a year ago. In view of the overall drop in stress on the domestic financial market, it was therefore natural to reduce the frequency of the liquidity-providing two-week repo operations and to reintroduce the previously applied interest mark-up of 0.1 pp in the facility for credit institutions.
The results of the public finance stress test and potential developments in the sovereign risk area were briefly evaluated. The test results showed that sovereign risk remained relatively low in spite of sizeable public budget deficits. Sovereign risk was also being positively affected by growth in the average maturity of government bonds in recent years. However, insufficiently credible consolidation measures following the end of the pandemic could start to foster growth in the sovereign risk premium. In view of domestic financial intermediaries’ substantial investments in Czech government bonds, some of the board members emphasised the need to devote increased attention to sovereign risk analyses and actively communicate their results.
The second part of the meeting focused on risks connected with mortgage lending and the residential property market. According to the presentation given by the Financial Stability Department, the movement up the spiral between debt financing of property purchases and rising property prices had strengthened in the second half of 2020. The estimated overvaluation of apartment prices for the median household had increased slightly in this period to an average of 18%, while in selected localities with a high share of investment apartments it might be as high as 25%. The CNB’s projection prepared for stress-testing purposes assumed that year-on-year house price growth would remain strong in the first half of 2021 and then start to weaken gradually due to rising interest rates on housing loans and to base effects. The adverse situation in the real economy had not passed through to the mortgage market. The volumes of genuinely new housing loans (excluding refinanced and refixed loans) had reached record highs in the second half of last year and the first few months of this year. This was due mainly to a marked rise in the average loan size, whereas the numbers of genuinely new mortgage loans had not been beyond those common in previous years. Mortgage lenders had complied with the recommended 90% LTV limit in the second half of last year and the first two months of this year. DTI and DSTI caps had not been applied in the said period. However, lenders had not abided too much by the DTI and DSTI thresholds above which the CNB – based on the conclusions of its analyses and stress tests – usually regards loans as very risky. The share of higher-risk mortgage loans had increased in the second half of 2020. In the last quarter of the year, banks had provided over 30% of the relevant reference volume of loans with a DSTI of over 40%. Similar tendencies could also be observed for the DTI ratio. At the end of its presentation, the Financial Stability Department confirmed that the risks were rising and that it would be natural to react to them by returning to tighter parameters of the CNB Recommendation. However, the intensity of these risks was limited for now, so a stricter approach was not essential at the moment.
In the following discussion, the board members agreed that the robustness of the growth in house prices and new mortgage loans was surprising. This was true for the Czech Republic and for the majority of advanced countries. It was said that economists had probably underestimated the importance of specific circumstances connected with the pandemic. These included growth in demand for large apartments, housing outside cities and recreational properties. Some of these factors might be longer-lasting. Nonetheless, there was agreement with the Financial Stability Department’s estimate that both variables were highly likely to slow in the quarters ahead. However, the opinion was also expressed that mortgage loans were currently a key product for banks in terms of profitability and that banks were likely to continue to try to expand their credit portfolios in this category.
A majority of the board members supported the proposal not to tighten the CNB Recommendation at the present time, even though the signals of a marked easing of credit standards were unmistakable. They regarded it as sufficient for now for the CNB to respond to the risks associated with the highly relaxed credit standards of some lenders with microprudential supervisory tools, primarily under the SREP. In the SREP it is possible to take into account not only banks’ approach to credit ratios, but also other characteristics of credit standards. The arguments given for maintaining the present conditions included the more or less stable numbers of genuinely new mortgage loans, the concentration of risky loans in a small set of lenders, the non-rising share of buy-to-let mortgages, and the observed high resilience of the mortgage portfolio to adverse shocks, as confirmed by the household stress test. Macroprudential measures should only be considered in the event of a broad increase in risks.
Emphasis was also placed on the fact that it was more appropriate to activate DTI and DSTI ratios in a situation where cyclical risks are increasing sharply and the CNB simultaneously considers it highly likely that a cyclical downturn is imminent, which, however, was not the case at present. It was also said repeatedly that lenders’ very awareness of the risks associated with high DTI and DSTI ratios – an awareness which had formed thanks to the application of DTI and DSTI caps between autumn 2018 and spring 2020 – was currently having a stabilising effect. However, the Bank Board agreed that lenders should take measures to ensure that loans with a DSTI ratio of over 40% of net income and a DTI ratio of over eight times net annual income are provided only to applicants who are highly likely to repay without problems. It was said repeatedly that credit standards could be described as being as relaxed as acceptable. If, due to competition, they were eased any further, the CNB would have to react using macroprudential policy tools.
Part of the discussion was devoted to the CNB’s approach to the regulation of mortgage lending following the very recent adoption of an amendment to the Act on the CNB giving the central bank the option of setting legally binding LTV, DTI and DSTI caps. In reality, though, the CNB would not have recourse to this option for several months yet, so it would not be appropriate to discuss a new approach to the regulation of mortgage lending until the Bank Board’s autumn meeting on financial stability issues. It was also true that any caps announced under the amendment to the Act on the CNB would actually take effect at least four months after the Bank Board made the relevant decision, i.e. not until next year. Some of the board members recognised the option of moderately tightening the LTV cap and already starting to apply a limit 10 percentage points higher in the case of loan applicants under 36 years of age. After a thorough discussion, however, they agreed with the majority Bank Board opinion to transition to setting credit ratio limits in accordance with the amendment to the Act on the CNB only after the amendment took effect. One board member moved for a vote to tighten the LTV cap to 80% while maintaining the 5% volume exemption.
In a discussion of house prices, some of the board members noted that part of the public believed it was the CNB’s job to ensure house price stability. This notwithstanding, it was the CNB’s job to mitigate systemic risks to financial stability, which house prices affect only indirectly. If tighter macroprudential policy were to result in weaker house price growth, this would only be a side-effect of such policy. It would also be a highly uncertain effect. The Bank Board agreed that supporting supply on the residential property market could be far more effective in stabilising house prices. According to some of the board members, higher taxation of housing purchased as an investment might also help stabilise prices. The experience in other countries indicated that, besides configuring property tax appropriately, removing various forms of tax aid supporting house buying on debt, such as tax deductibility of mortgage interest, counteracts worsening affordability of housing. One of the board members emphasised that containment of inflation expectations and growth in real interest rates should help slow the rise in house prices.
Following the presentation of the Financial Stability Report and the subsequent discussion, the Bank Board decided to increase the countercyclical capital buffer rate for exposures located in the Czech Republic to 1% with effect from 1 July 2022. The Bank Board also confirmed the LTV limit at 90%.
Author of the minutes: Jan Frait, Executive Director, Financial Stability Department