Minutes of the CNB Bank Board meeting on financial stability issues on 1 June 2023

Present at the meeting: Aleš Michl, Eva Zamrazilová (not present for the vote), Jan Frait, Karina Kubelková, Tomáš Holub, Jan Kubíček, Jan Procházka

The meeting opened with a presentation given by the Financial Stability Department on the main conclusions of Financial Stability Report – Spring 2023. The presentation focused mainly on the position of the Czech economy in the financial cycle and the situation on the residential property market, including systemic risks associated with the debt financing of residential property. Following the Financial Stability Department’s presentation, the Board first discussed the countercyclical buffer rate and then assessed developments on the mortgage market and residential property market and the upper limits on the LTV, DTI and DSTI ratios. As well as debating the settings of macroprudential instruments, the board members discussed the relationship between monetary and macroprudential policy.

Governor Aleš Michl emphasised that the objectives of price and financial stability were intertwined and that at a time when the CNB’s main objective was to reduce inflation substantially, the macroprudential policy settings also had to be quite tight. The view that the settings of macroprudential instruments had to be considered in a broader context and had to take the overall macroeconomic environment into account was shared by a majority of the board members. Jan Procházka pointed out that in the current situation it was inappropriate for the two policies to push against each other and, despite the partial decrease in systemic risks, some caution had be applied in macroprudential policy. He also explained that he understood systemic risk in the broader sense of a risk of greater volatility of macro-financial variables, especially loans and house prices, not just a direct threat to the stability of the financial sector. Deputy Governor Jan Frait and Tomáš Holub also agreed with interconnectedness in decision-making on the macroprudential and monetary policy settings. On the other hand, Tomáš Holub expressed his conviction that the objectives of price and financial stability are not the same and that, when there are multiple objectives, it is necessary to rely primarily on different sets of instruments to achieve them. In this regard, Deputy Governor Eva Zamrazilová pointed out that the inconsistency in the settings of the two policies was difficult to communicate in the current situation and could generate incorrect signals regarding future interest rate developments if not understood by market participants.

The countercyclical buffer (CCyB) rate

In the part of the Financial Stability Department’s presentation dealing with the CCyB rate, it was said that the domestic economy was now clearly past the peak of the financial cycle. The inflow of new cyclical risks was very subdued and the previously accumulated cyclical risks were slowly receding from the banking sector’s balance sheets without any surge in loan defaults. The level of risk nonetheless remained elevated, partly because of persisting geopolitical risks, the materialisation of which could potentially result in an increase in defaults in the future.

In the following discussion, the board members agreed that the domestic economy had now passed the peak of the financial cycle and had entered a downward phase, with which a gradual reduction of the countercyclical capital buffer rate was consistent. The prevailing view among the board members was that a partial easing would not provide any additional impetus to lending, as banks’ credit supply was no longer constrained by their level of capital. Deputy Governor Jan Frait and Jan Kubíček said that starting the process of lowering the rate was consistent with the principle of operation of the CCyB and would not have a material impact on the stability and functioning of the banking sector. Deputy Governor Jan Frait also mentioned that part of the banking sector was likely to continue to hold a similar level of capital even at a lower CCyB rate due to the obligation to meet the minimum requirement for own funds and eligible liabilities (MREL), which would start to apply to the full extent in 2024. The risk of the capital released being used imprudently or being paid out fully as dividends was therefore very low.

In a discussion on the optimal rate of reduction of the CCyB rate, Karina Kubelková and Tomáš Holub considered a faster pace to be consistent with the extent of cyclical risks accumulated in the banking sector’s balance sheets. Tomáš Holub pointed out that the quantitative methods used as a guide to setting the CCyB rate indicated a need for a CCyB rate of 2%. Therefore, a 0.25 pp reduction of the CCyB rate to 2.25% could still be considered a relatively tight and prudent macroprudential policy stance. Despite having slightly different preferences regarding the speed of reduction of the CCyB rate, all the board members agreed that there was room to continue the process of lowering the CCyB rate in the coming quarters if the projected future developments materialised. Similarly, there was complete agreement among the board members that, given the available information, an increase in the rate in the coming year could in all probability be ruled out and that only a vote on maintaining or lowering the rate was likely to be taken during that period.

After the discussion, the Board decided to lower the CCyB rate by 25 bp with effect from 1 July 2023. All six board members present voted in favour of the reduction (Deputy Governor Eva Zamrazilová was no longer present for the vote).

Upper limits on the LTV, DSTI and DTI credit ratios

The second part of the Board’s meeting was focused on risks connected with the provision of consumer loans secured by residential property, developments on the residential property market, and the upper limits on the LTV, DSTI and DTI credit ratios applicable since 1 April 2022. In the Financial Stability Department’s presentation, it was said that the volume of new housing loans had fallen significantly during 2022 and had also been at low levels during the first few months of 2023. Transaction prices of residential property had reached their cyclical peak in mid-2022 and had since been flat or, in some segments and regions, had recorded declines. Overall, lenders had been complying with the binding limits on credit ratios, and this had led to an improvement in loan portfolio quality.

In the debate on the property market, the board members agreed that the situation had calmed somewhat, but that the market was still showing signs of overheating from the past. According to Deputy Governor Eva Zamrazilová the market had not yet cooled sufficiently and, in the event of an adverse economic shock, prices could fall significantly and banks could potentially incur increased credit losses. Jan Kubíček noted that the domestic correction of residential property prices had been relatively small in international comparison and the risk associated with their continued overvaluation persisted, despite having decreased somewhat. Tomáš Holub agreed. For him, the coverage of the risks associated with the degree of overvaluation by means of credit limits had been borderline in the past. The slight decrease in the magnitude of the overvaluation was thus merely bringing the LTV ratio into line with the personally perceived level of risk.

The Board devoted a substantial part of the debate to discussing the impact of the upper limits on credit ratios on future credit growth. Governor Aleš Michl reiterated that credit growth is a key determinant of future inflation and that, in the current conditions, it was therefore necessary to keep the credit ratios tight for a successful return of inflation to the inflation target. A similar opinion was expressed by Deputy Governor Eva Zamrazilová, who did not consider the battle against excess money in the economy to have been won; any action potentially stimulating further credit growth was not an appropriate signal for the economy. The other board members also agreed that there were significant uncertainties that could lead to a significant recovery in housing loans if the credit ratios were deactivated. Jan Procházka pointed out that the labour market remained tight and, given the close link between employment and the mortgage market, lending could recover quickly. According to Tomáš Holub, the gradual decline in inflation pressures and the subsequent reduction in monetary policy rates, which would pass through to mortgage rates and make credit available to a wider set of households, could also contribute to the recovery. In the balance of arguments about the effect of the credit ratios, Karina Kubelková on the other hand pointed out that the impacts of the credit ratios were probably smaller than was being considered in the debate and that it was also necessary to take into account the role of (micro) supervision of banks, which was closely monitoring the assessment of credit risks in individual banks and would be able to react to imprudent behaviour by banks in the area of lending for house purchase.

Finally, the board members discussed the actual settings of the upper limits on credit ratios. In view of the assessment of the property market situation and the persisting overvaluation of prices, a majority of the board members agreed that the upper limit on the LTV ratio should be maintained. Karina Kubelková could imagine it being deactivated, similarly to the other credit ratios. The main argument for her was the limited impact of such a move on systemic risk, even if lending activity on the mortgage market were to recover. Given the effects of the elevated interest rates, she did not fear a significant increase in mortgage lending. Removing the caps would not send a signal that mortgage lending was now less risky; it would merely indicate that we can now leave the management of risks entirely to lenders themselves. The other board members were in favour of a higher degree of caution, partly due to the monetary policy aspects. Deputy Governor Jan Frait said that, given the persisting and significant overestimation of the price of housing, particularly under the prudential estimation method, he considered it desirable to maintain not only an LTV limit, but also a DTI limit where appropriate, whether in the form of a provision of a general nature or a recommendation. He agreed with the Financial Stability Department that major systemic risks were unlikely to form under the current conditions, but in his view the conditions could change relatively quickly and caution was therefore appropriate. Governor Aleš Michl, Deputy Governor Jan Frait, Tomáš Holub and Jan Procházka nonetheless agreed that a DSTI ceiling did not need to be applied in the current circumstances. This ratio is of key importance in times of low interest rates, when a future return to higher interest rates can significantly increase household debt service. However, according to these Board members, we were not in such a situation now. Deputy Governor Eva Zamrazilová, however, drew attention to the possible risk of a future increase in the cost of living due to growth in retail energy prices, which would have a similar effect to an increase in interest rates.

Instead of deactivating the upper DSTI limit, Jan Kubíček proposed moving it higher. He considered this step to be more prudent, as it would prevent the provision of loans with very risky characteristics. However, the other board members argued that deactivating the DSTI would limit access to credit to only specific groups of clients and that there was no need to fear a significant rise in the riskiness or volumes of loans. The retention of the upper DTI limit served as a safeguard against these tendencies. With regard to a potential shift of the DSTI ceiling, Deputy Governor Jan Frait expressed concern that the market and the public could misconstrue this measure as a kind of guide to what levels the CNB still considered risk-free. This, however, would not in line with the CNB’s long-term view of the DTI and DSTI levels at which loans can be considered high-risk. He and Tomáš Holub pointed out that the CNB’s recommendation on the management of risks associated with the provision of consumer credit secured by residential property, which represents a soft form of management of the upper limits on credit ratios, remained in force. This recommendation states that the CNB considers loans with a DSTI above 40% and a DTI above 8 to be higher-risk loans.

After the discussion, the Board decided to leave the upper limits on the LTV and DTI ratios unchanged and to deactivate the upper limit on the DSTI ratio with effect from 1 July 2023. Four board members, Aleš Michl, Jan Frait, Tomáš Holub and Jan Procházka, voted to leave the upper limit on the LTV ratio at 80% (90% for applicants under 36 years purchasing owner-occupied housing) and the upper limit on the DTI ratio at 8.5 times net annual income (9.5 times for applicants under 36 years) and to deactivate the upper limit on the DSTI ratio. Jan Kubíček, who was in favour of raising the upper DSTI limit, abstained, and Karina Kubelková voted against maintaining the upper LTV and DTI limits.

Author of the minutes: Miroslav Plašil, Financial Stability Department