The implementation of the countercyclical capital buffer: Practice and implications

In order to deal with the procyclical effects of bank lending, a countercyclical capital buffer (CCyB) has been adopted in many jurisdictions since the global financial crisis (GFC). Some jurisdictions follow an automatic approach and basethe decisions on the results of financial and economic indicators. Alternatively,others adopt a discretionary approach, which gives leeway to regulators to adjust the buffer rate. The automatic approach lacks flexibility and cannot avoid technical errors, whereas the discretionary approach embeds more cognitive and political bias. Considering these flaws, some jurisdictions have required banks to maintain a positive CCyB at all times, which is known as the precautionary approach. However, this strategy attenuates the role of the CCyB as a countercyclical tool. Regulatory responses to the recent economic recession caused by the COVID-19 pandemic demonstrate that jurisdictions with a positive CCyB have more capacity to adjust capital requirements, but this may lead to a misunderstanding that the precautionary approach is the correct way to implement the CCyB. In fact, the best options to deal with such a crisis are non-cyclical buffers, whereas the functions of the CCyB in early warning and slowing down the build-up of risks should be prioritised. Therefore, the precautionary approach should not be applied and the role in coping with unpredicted and unexpected situations should be shifted to other buffers.