Provision of a general nature II/2021

of 27 May 2021

on setting the countercyclical capital buffer rate for the Czech Republic No. II/2021

Pursuant to Article 12o(5) of Act No. 21/1992 Coll., on Banks, as amended by Act No. 375/2015 Coll., (hereinafter referred to as the “Act on Banks”) and Article 8al(5) of Act No. 87/1995 Coll., on Credit Unions and Certain Related Measures and on the Amendment of Czech National Council Act No. 586/1992 Coll., on Income Taxes, as amended, as amended by Act No. 375/2015 Coll. (hereinafter referred to as the “Act on Credit Unions”), the Czech National Bank as a competent administrative body hereby issues the following provision of a general nature:

I. Pursuant to Article 12o(3) of the Act on Banks and Article 8al(3) of the Act on Credit Unions, the countercyclical capital buffer rate for the Czech Republic shall be set at 1.00% of the total risk exposure amount pursuant to Article 92(3) of Regulation (EU) No. 575/2013 of the European Parliament and of the Council.

II. Banks and credit unions shall apply the rate referred to in point I for the purposes of calculating the combined buffer requirement as from 1 July 2022.

Justification

1. Pursuant to Article 12o(3) of the Act on Banks and Article 8al(3) of the Act on Credit Unions, the Czech National Bank (hereinafter referred to as the “CNB”) shall set the countercyclical capital buffer rate for the Czech Republic, taking into account the countercyclical capital buffer guide calculated pursuant to Article 12o(1) and (2) of the Act on Banks and Article 8al(1) and (2) of the Act on Credit Unions, the recommendations issued by the European Systemic Risk Board (hereinafter referred to as the “ESRB”) and indicators which may imply growth in systemic risk.
2. Pursuant to Article 12o(1) of the Act on Banks, Article 8al(1) of the Act on Credit Unions and Article 9al(1) of the Capital Market Undertakings Act, the calculation of the buffer guide is based on the deviation of the credit-to-GDP ratio from its long-term trend – the credit-to-GDP gap. The credit-to-GDP ratio was 91.3% and the relevant deviation from the long-term trend -1.3 percentage points in 2020 Q4.^[1] This value pursuant to Article 12o(1) of the Act on Banks and Article 8al(1) of the Act on Credit Unions corresponds to a benchmark countercyclical capital buffer rate of 0%. The additional gap,^[2] which is based on the ESRB Recommendation (section B, Article 2) and better reflects the specificities of the Czech economy, was 4.7 percentage points in 2020 Q4 and implies a benchmark rate of 1.00%.
3. In reaction to the ESRB recommendation, the CNB has repeatedly emphasised in its publications (particularly the Financial Stability Report) that it does not regard the size of the gaps referred to in paragraph 2 as a reliable guide for determining the position of the domestic economy in the financial cycle and setting the rate. The CNB prefers an approach based on a comprehensive assessment of indicators identifying growth in systemic risks under Article 12o(3) of the Act on Banks and Article 8al(3) of the Act on Credit Unions.^[3]
4. The value of financial cycle indicator increased year on year in 2020 Q4, mainly as a result of increasing debt financing of residential property purchases. The sectoral nature of the new risks is evidenced by the growth rate of loans to households for house purchase, which recorded a year-on-year rise. This contributed to accelerating growth in residential property prices, particularly apartment prices, which, according to the CNB’s estimate, were overvalued by 18%–25% at the end of 2020. Conversely, a slowdown in the growth rate into negative territory was observed in 2021 Q1 for consumer credit provided to households and loans to non-financial corporations.^[4] Due to low interest rates on loans for house purchase (which are negative when adjusted for inflation) and investment-motivated property purchases by some households, the taking on of new risks in banks’ balance sheets increased. It can be expected to remain elevated in the quarters ahead. Coupled with low materialisation of risks taken on in the past accompanied by a decline in provisioning at the start of 2021, the aggregate risks in banks’ balance sheets thus also remain elevated. Cyclically lowered risk weights in the loan portfolios of banks applying the IRB approach^[5] also remain a source of systemic risk. A return of risk weights to the levels observed at the start of the last strongly expansionary phase of the financial cycle^[6] would lead to a drop in the capital ratio as a result of an increase in risk-weighted exposures (the denominator of the capital ratio). It would then be necessary to increase the volume of capital in absolute terms to maintain the capital ratio. The estimated size of unexpected credit losses along with the potential rise in risk weights implies an additional capital requirement of around CZK 45.4 billion, which would be fully covered by a buffer rate of 1.75%. This estimate may be overvalued, as it is affected by factors other than purely cyclical ones. However, it confirms the necessity to continue to create a countercyclical capital buffer and indicates a need to return its rate to the standard level covering the usual level of cyclical risks (considered by the CNB to be 1%).
5. Based on the above assessment, the CNB Bank Board has decided to set the countercyclical capital buffer rate at 1.00%.^[7] In the event of continued rapid credit growth in the household sector, renewed positive growth in loans to non-financial corporations and faster taking on of risks in the banking sector’s balance sheet, the Bank Board is ready to increase this rate further. By contrast, should the economic situation worsen again due, for example, to another wave of the pandemic, the Bank Board will be ready to release the buffer immediately and fully, in order to support banks’ ability to provide credit to non-financial corporations and households without interruption. The decisive signal for such a step would be a significant worsening of the economic situation, cyclical risks accepted earlier materialising via credit losses and an increase in risk weights for IRB loan portfolios.
6. Pursuant to Article 12x(1) of the Act on Bank and Article 8au(1) of the Act on Credit Unions, this provision of a general nature is announced only in a manner facilitating remote access and takes effect on the day of its publication.

Effect

This Provision shall take effect on 28 May 2021.

This provision of a general nature was published on 28 May 2021.

^[1] In accordance with ESRB Recommendation 2014/1 (Recommendation of the European Systemic Risk Board of 18 June 2014 on guidance for setting countercyclical buffer rates), total credit means the value of all loans provided to the private sector (non-financial corporations, households and non-profit institutions serving households) plus the volume of bonds issued by the domestic private sector. The time series of 1995 Q1–2020 Q4 and the Hodrick-Prescott filter with a smoothing parameter (λ) of 400,000 are used to calculate the long-term trend of the credit-to-GDP ratio.

^[2] The additional gap – the expansionary credit gap – is calculated as the difference between the current ratio of bank loans to gross value added of the private non-financial sector and the minimum level of this ratio achieved in the past eight quarters.

^[3] The methodological framework of the Czech National Bank for setting the countercyclical buffer rate is presented in the document The CNB’s approach to setting the countercyclical capital buffer.

^[4] The annual growth rates of bank loans provided to households for house purchase and for consumption were 8.6% and 0.1% respectively in March 2021. Bank loans to non-financial corporations decreased by 2.4% year on year in March 2021.

^[5] Cyclical factors are not the only factors affecting risk weights, so the latter may not always solely reflect the latest economic developments. This applies particularly to changes in banks’ models for deriving risk weights or to regulatory changes. The risk weights on the exposures of non-financial corporations were adjusted for a regulatory change of a non-cyclical nature. In Q2, this change broadened the range of corporate exposures to which the supporting factor for small and medium-sized enterprises lowering the risk weight can be applied.

^[6] According to the CNB’s estimate, the Czech economy entered the last strongly expansionary phase of the financial cycle in 2015 H2.

^[7] Institutions shall apply a countercyclical capital buffer rate of 1.00% of the total risk exposure for the purposes of calculating the combined buffer requirement as from 1 July 2022. They shall apply a rate of 0.50% for the purposes of calculating the combined capital buffer until 30 June 2022.