Minutes of the CNB Bank Board meeting on financial stability issues on 29 November 2023
Present at the meeting: Aleš Michl, Eva Zamrazilová, 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 – Autumn 2023. The presentation focused on assessing the cyclical risks arising from the present position of the Czech economy in the financial cycle, the situation on the residential property market and the systemic risks associated with the debt financing of residential property purchases. Besides these topics, the presentation dealt with the structural systemic risks in the Czech economy and their potential impacts on financial stability. The Bank Board then discussed the countercyclical buffer rate, assessed the situation on the mortgage market and residential property market and decided on reconfiguring the upper limits on the LTV, DTI and DSTI ratios. The Bank Board’s discussion also covered structural risks and their relationship with cyclical risks.
In a general discussion about the configuration of macroprudential policy instruments, Governor Aleš Michl said he supported generally tight settings. However, he emphasised that macroprudential policy had to be considered in a comprehensive manner and its overall effect should be taken into account. In the present environment, when systemic risks were tending to recede or stagnate, the settings of the individual instruments should not lead to an overall tightening of macroprudential policy. The other board members agreed with this. A majority of the board members concurred that in the area of macroprudential capital buffers in particular, there was a need to carefully consider their overall level, taking into account the different reasons for activating them.
In a discussion about structural systemic risks, it was said that this area would require increased attention going forward. In its presentation, the Financial Stability Department said that certain types of structural risk persisted in the domestic economy and, in the event of a highly adverse shock, they could exacerbate the downswing in the domestic economy and amplify its impacts on the banking sector. The risk factors included in particular the high openness and energy intensity of the Czech economy. Their contribution to the potential disruption of financial stability might not be negligible in an environment of elevated geopolitical uncertainty, high euro financing of non-financial corporations and a necessary transition to a low-emissions economy.
In the ensuing discussion, Deputy Governor Jan Frait said that the economic model, characterised by a heavy reliance on neighbouring countries, especially Germany, had been quite successful in the past, but its potential was gradually being exhausted and it could now face a stern test. For this reason, it made sense to open a fundamental debate about structural risks and have measures ready that would ensure the banking sector remained resilient even to extreme risks in the long term. On the other hand, Deputy Governor Eva Zamrazilová, Jan Procházka and Jan Kubíček did not view these risks as substantial. In their opinion, the banking sector had learned to manage these risks well itself when lending, as it had been constantly exposed to them and had long experience of them. Tomáš Holub pointed out that these risks might already be partially covered by the countercyclical capital buffer, as it was not easy to fully differentiate the effects of cyclical and structural risks. He personally regarded the level of cyclical risks as low in relation to the level of the countercyclical capital buffer rate; for him, the existence of structural risks had, in the recent past, been an argument for only gradually lowering the rate. Against this, Karina Kubelková expressed the belief that the countercyclical capital buffer currently only covered the cyclical risks and it made sense to start discussing the possibility of taking structural risks into consideration in the configuration of macroprudential policy instruments.
At the end of the discussion of structural risks, the board members agreed it was difficult to quantify exactly their potential impact on the banking sector given the low likelihood of them materialising, and further detailed analysis of the issue would be necessary. There was also a need to carefully assess the interlinkages between the structural and cyclical macroprudential instruments and the microprudential supervisory tools.
The countercyclical buffer (CCyB) rate
In the part of its presentation dealing with the CCyB rate, the Financial Stability Department said that the domestic economy was in a greatly subdued phase of the financial cycle. The inflow of new cyclical risks was very limited and was highly likely to remain low over the next two years despite the expected recovery of the economy and lending activity. 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, and, given the low level of credit losses seen to date, a significant rise in such losses could not be ruled out in an environment of continued global and domestic uncertainty.
The board members agreed with the Financial Stability Department’s assessment in the area of cyclical risks and the position of the economy in the financial cycle. They concurred that given the highly subdued inflow of new risks, there was room to lower the CCyB rate further, so the process of reducing it would probably continue in the next few quarters. The Board then discussed the desirable degree of prudence and its effect on the speed of reducing the buffer. The prevailing view among the board members was that the previously accumulated risks remained sizeable and caution was appropriate. Jan Frait emphasised that the Czech economy was currently in a mild recession, which was not being accompanied by appreciable growth in defaults even though the cost of risk had risen modestly. It was possible that the effect of the recession would be felt with a lag, so he supported the option of not rushing into lowering the CCyB rate and of waiting for more data. Given the possibility of deciding on the buffer rate four times a year, a majority of the board members supported this view. Tomáš Holub agreed that the financial cycle was currently in a very subdued phase and that the tight monetary policy stance was contributing significantly to this. Given this assessment, however, he would consider it consistent to continue gradually lowering the CCyB rate. He felt that the trend in risk weights, whose decline in recent years he regarded as largely structural rather than cyclical, also spoke in favour of a smooth downward course. In this situation, risk weights were unlikely to return to their original higher levels and would not put as much downward pressure on the capital ratio as the relevant quantitative method was predicting.
After the discussion, the Board decided to leave the CCyB rate at 2%. Six of the board members present (Aleš Michl, Eva Zamrazilová, Jan Frait, Karina Kubelková, Jan Kubíček, Jan Procházka) voted to keep it unchanged, while one board member (Tomáš Holub) voted to lower it by 0.25 pp to 1.75%.
Upper limits on credit ratios
In the second part of the Board’s meeting, there was a discussion of the risks connected with the provision of consumer loans secured by residential property and with developments on the residential property market. In the Financial Stability Department’s presentation, it was said that the volume of new housing loans had fallen well below the long-term average for 2014–2022 in the first nine months of 2023, partly due to the still elevated interest rates. As expected, the share of loans with high DSTI ratios in new loans had increased following the deactivation of the upper limit on the DSTI ratio on 1 July 2023, but their total amount remained very low. Considering the individual characteristics of these loans, this was not creating potential for a build-up of systemic risks. Banks were continuing to comply with the binding upper limits on the LTV and DSTI ratios, while the permitted 5% exemption was not taken up fully at the aggregate level.
In the following discussion, the board members agreed that when configuring the upper limits on the credit ratios, it was necessary to abide by the present legislation and base the decision on the identification of systemic risks. Deputy Governor Eva Zamrazilová and Jan Kubíček nonetheless emphasised that the primary focus when interpreting the law should be on its spirit. The Board’s decision-making should thus be guided above all by the existence of risks in the long term.
In this debate, Karina Kubelková said she considered the potential for the formation and accumulation of systemic risks to be very low after the period of application of upper limits on credit ratios and tight monetary policy. For at least the next two years, she did not foresee any threat to financial stability that could not be covered with macroprudential capital buffers or managed via the softer option of recommended limits on credit ratios. Jan Frait agreed that the risks associated with new lending in the housing area were low and the portfolio in this segment was likely to remain in very good condition unless the unemployment rate went up significantly. Jan Frait and Jan Procházka then expressed the opinion that given the current level of risks, the Board could build on the deactivation of the upper limit on the DSTI ratio in July and further soften the rules applying to the provision of housing loans. Tomáš Holub agreed but noted that he saw some risk of a faster upswing in the financial cycle by comparison with the opinion of the Financial Stability Department. Reductions in monetary policy rates during 2024 could support latent deferred demand for property. If supply remained constrained in the long term, this could cause property prices to accelerate, foster a pick-up in debt financing of property purchases and ultimately lead to a build-up of risks.
In a discussion of the upper limits on credit ratios, Governor Aleš Michl said that in the current circumstances, he preferred to manage the risks at the macro-level using the LTV ratio. On the one hand, the LTV ratio reduces the risk of banks incurring credit losses, due to the maintenance of sufficient collateral value. On the other, it motivates borrowers to repay, due to the requirement that they part-finance the purchase themselves. At the current property price levels, the necessary down payment was quite large and the motivation to repay sufficiently high. Jan Procházka agreed that the upper LTV limit was able to reduce moral hazard. He expressed the opinion that borrowers contributing very little equity of their own might behave less prudently when buying property and that this type of mortgage should not be provided under any market conditions.
All the board members agreed that given the continuing overvaluation of residential property prices and the heightened uncertainty, there was still some risk of a significant future price correction, even though it had probably started to decrease. For all the board members except Karina Kubelková, this risk constituted a major argument for maintaining a prudent upper limit on the LTV ratio. Karina Kubelková conceded that deactivating the upper limit on the LTV ratio might imply some increase in high-risk loans in banks’ portfolios. Nonetheless, in her view this increase did not have the potential to contribute significantly to a build-up of systemic risks, which was what mattered from the perspective of the law. The other board members agreed that deactivating the LTV would not lead to an immediate disruption of financial stability. However, they highlighted its potential longer-term consequences. In the longer run, the risks might not decrease as desired and could build up further, culminating in problems in the banking sector in the future.
In a discussion about the upper DTI limit, it was said that there was no longer any need to apply the limit in the current credit environment (Karina Kubelková) or that the reasons for retaining it had weakened appreciably, so the binding rules could be relaxed further (Jan Frait, Tomáš Holub, Jan Procházka). On the other hand, Eva Zamrazilová and Jan Kubíček argued that the DTI ratio was very closely linked to property prices, which remained high. The DTI ratio therefore remained important for keeping systemic risks low. These board members meanwhile emphasised that their preferred approach was to recalibrate the upper limits on credit ratios gradually rather than deactivate them completely. In this regard, Eva Zamrazilová noted the recent recommendation of the IMF mission calling for the DSTI to be reinstated and emphasising that it was appropriate to recalibrate the limits. Jan Kubíček also pointed out that the statistical survey of compliance with the limits only covers successful loan applicants and so does not provide a full picture of the credit market as a whole. In his opinion, the number of applicants willing to enter the market under softer conditions could be high. This could lead to growth in systemic risks if the DTI were to be deactivated.
After the discussion, the Board decided to leave the upper limit on the LTV ratio at 80% (90% for applicants under 36 years purchasing owner-occupied housing) and to deactivate the upper limit on the DTI ratio with effect from 1 July 2023. Six board members (Aleš Michl, Eva Zamrazilová, Jan Frait, Jan Holub, Jan Kubíček, Jan Procházka) voted to leave the upper limit on the LTV ratio unchanged and one member (Karina Kubelková) voted to deactivate it. Five board members (Aleš Michl, Jan Frait, Karina Kubelková, Tomáš Holub, Jan Procházka) voted to deactivate the upper limit on the DTI ratio and two members (Eva Zamrazilová, Jan Kubíček) voted to leave it at 8.5 times net annual income (9.5 times for applicants under 36 years).
Author of the minutes: Miroslav Plašil, Financial Stability Department