Minutes of the CNB Bank Board meeting on financial stability issues on 18 June 2020
Present at the meeting: Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Vojtěch Benda, Oldřich Dědek, Tomáš Holub, Aleš Michl.
The meeting opened with a presentation of Financial Stability Report 2019/2020, which focused mainly on risks to the future stability of the domestic financial sector associated with the COVID-19 pandemic, the turnaround in the financial cycle, an assessment of banking sector resilience, and changes in the level of risks connected with mortgage lending. Following the opening presentation, the Bank Board discussed the setting of the countercyclical capital buffer (CCyB) rate, the capital cushions necessary to maintain stability even in the case of highly adverse developments, and additional potential changes to macroprudential instruments targeted at risks connected with mortgage lending.
The presentation given by the Financial Stability Department on the CCyB emphasised that, according to the aggregate Financial Cycle Indicator as well as other indicators, the domestic economy had entered the recessionary phase of the financial cycle this year. Despite a sharp economic deterioration, the cyclical risks accepted in the previous expansionary phase of the cycle were not materialising systemically in the banking sector so far. However, the deterioration in the economic conditions would be manifested in a drop in credit portfolio quality and a rise in credit losses in the quarters ahead. Increasing default rates would probably also lead to a gradual rise in risk weights. In this situation, the Financial Stability Department preferred to proceed in line with the recently published methodology, according to which the CCyB rate was to be lowered gradually in connection with the materialisation of the above risks. A gradual release of the existing CCyB should support the ability of banks to finance the real economy.
In the discussion that followed, the board members agreed that the financial cycle had entered the recessionary phase and newly accepted cyclical risks would be decreasing. There was also a consensus that the domestic banking sector would be faced with materialisation of previously accepted cyclical risks and that releasing the CCyB was a desirable reaction. The first step had been the preventive forward-looking March decision to lower the CCyB rate from 1.75% to 1% with effect from the start of April. The main subject of the Bank Board's subsequent discussion was whether to cut the rate further now in view of the evident future increase in credit losses or to wait until increased losses start to occur. In support of immediate continuation with the release of the CCyB, it was said that in the situation the economy is now in, macroprudential policy should react anti-cyclically and do its utmost to mitigate the risk of a deteriorating capital position of banks adversely affecting the price and availability of credit. Other board members argued that, at their current level of capitalisation, banks had considerable lending capacity and a CCyB rate of 1% would not constitute a barrier to the supply of credit. In addition, it was discussed how, if the rate were lowered, to meet the regulatory requirement to indicate a time horizon at which the CCyB rate might be increased again. There was a consensus that the horizon would probably be relatively long and, given the exceptionally high level of uncertainty, any indication would constitute merely formal compliance with the regulatory rules. Moreover, when a cycle of lowering the CCyB rate is under way, such an indication could be confusing to the general public.
The subsequent part of the Bank Board's discussion focused on the CNB's approach to the use of banks' capital buffers (the capital conservation buffer and the systemic risk buffer) to absorb losses. The discussion reacted to the international debate about whether banks would prefer to curb lending due to concerns of stigmatisation should their capital ratio fall below the sum of Pillar 1, Pillar 2 and the buffers. The Bank Board agreed with the expert position according to which the buffers are clearly defined in EU law as a buffer to absorb banks' losses in bad times. It was therefore natural that, in the case of highly adverse developments in the domestic economy, banks temporarily would not comply with the capital conservation buffer and the systemic risk buffer after a potential full release of the CCyB, in order to provide services to their clients without interruption. This needed to be clearly communicated to banks, as they so far did not have practical experience with the use of capital buffers and the regulator's approach to this issue.
In connection with the results of the macro stress test of banks and future adjustments to the EU rules for setting capital buffers for systemically important institutions, the Bank Board also discussed the size of the total capital cushions necessary to maintain banking sector stability even in the case of highly adverse developments. The board members agreed that banks' current capital position was highly robust. Banks' resilience was also supported by retained earnings from last year and expected positive net profit also this year. At the same time, it could not be overlooked that the strong capital position was largely due to a capital surplus on top of the regulatory requirements and to earnings retained in conformity with the recommendations of the CNB and other European authorities (EBA, ESRB). As the recommendation of EU authorities to refrain from distributing earnings was to expire this year, there could be pressure to make sizeable dividend payments next year, even though the final impacts of the coronavirus crisis would be far from known. In addition, after the transposition of CRD V/CRR II into Czech law, the CNB would have to use the capital buffer for other systemically important institutions (the O-SII buffer) instead of the systemic risk buffer. As the CNB would be able to set the upper limit on the O-SII buffer no more than 1 pp above the foreign parent institution's buffer as set by its domestic regulator, the buffer rates of some domestic systemically important banks would in all probability decline. On the basis of an assessment of the above information, the view prevailed that premature withdrawal of a significant part of banks' capital surplus could become a source of systemic risk. Banks should thus refrain from making dividend payouts and taking any other action that might jeopardise their resilience until the uncertainty regarding the impacts of the coronavirus crisis on the banking sector disappears. The CNB stood ready to use all its supervisory and regulatory instruments to maintain the high resilience of the banking sector and its ability to lend to the real economy.
Developments in the non-banking financial institutions sector were also presented and discussed. According to the stress tests, the insurance sector remained resilient to risks and the capitalisation of pension management companies also appeared sufficient. Investment funds, which had allocated their assets in a riskier way in the previous period, should also be able to cope with the impacts of the coronavirus crisis.
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, apartment price overvaluation had grown slightly further in the second half of 2019, reaching 15%-25% at the end of last year according to both methods used by the CNB. According to available unofficial data for the first months of 2020, the pandemic had not significantly affected transaction prices so far. The estimate based on the Baseline Scenario did not expect prices to decrease either. Given the adverse developments in the real economy, however, there was potential for prices to decrease in the quarters ahead. The mortgage loan market had gradually recovered in the second half of 2019. In the first four months of this year, the volume of genuinely new mortgage loans had reached a record high compared with the same period in previous years. However, it could be expected that the impacts of the coronavirus crisis would manifest themselves in the months ahead and activity in this credit segment would decrease. The spiral between credit financing of property purchases and optimistic expectations of a future rise in property prices should halt as a result. The share of loans with LTVs of 80%-90%, which could account for a recommended maximum of 15% of new loans last year, had been below the recommended limit throughout 2019. However, some banks had continued to provide some loans with an individual LTV of over 90%, the level above which no loans should have been provided under the then valid Recommendation. As a result, they had provided more than 15% of new loans with an LTV of over 80%. Banks overall had been mostly compliant with the 5% exemption for loans with a DTI of over 9 and had only slightly exceeded this exemption for loans with a DSTI of over 45%. However, some of them had exceeded the DSTI exemption more markedly in the second half of last year.
In the subsequent discussion, the Bank Board focused mainly on potential reactions to a substantial change in market conditions. It agreed that the change of the rules effective from 1 April 2020 in the form of a softening of the LTV limit and the abolition of the recommended DTI limit had been an appropriate reaction in light of the subsequent developments. The Bank Board's view that, given the expected economic impacts of the coronavirus pandemic, lenders and their clients would be well aware of the risks and act in a conservative way, was also being confirmed. On the basis of information from the Bank Lending Survey, according to which banks had tightened their assessment of loan applicants' income situation, the possibility of abolishing the DSTI limit was discussed. Opinions were voiced that the limit on this indicator was important from the perspective of consumer protection and therefore remained of importance in bad times as well. However, the macroprudential view, according to which this limit would not be necessary in the near term given the absence of optimistic expectations, prevailed. Nevertheless, the Bank Board deemed it necessary to continue to point out to lenders that loans could usually be regarded as very risky above certain DTI and DSTI thresholds (a DTI of 8 and a DSTI of 40%). Lenders should therefore provide such loans with increased caution and only to applicants who are highly likely to repay without problems.
The discussion of the setting of the LTV limit also included views supporting its abolition or further slight easing. However, the opinion prevailed that, given the persisting house price overvaluation and the great uncertainty regarding future price developments, it was desirable to keep the existing limit of 90%. Specific cases should be covered by the 5% exemption. It was also said in support of maintaining an LTV limit that it had an important signalling role for loan applicants to invest at least some of their own savings in the purchase of housing. No later than at its November meeting, the Bank Board would reassess whether it would be necessary to amend the rules for mortgage lending by banks depending on market developments.
Following the presentation of the Financial Stability Report and the subsequent discussion, the Bank Board decided to lower the countercyclical capital buffer rate for exposures located in the Czech Republic to 0.5% with effect from 1 July 2020. It confirmed the LTV limit of 90% and abolished the DSTI limit.
Author of the minutes: Jan Frait, Executive Director, Financial Stability Department