Provision of a general nature II/2017

on setting the countercyclical capital buffer rate for the Czech Republic No. II/2017

of 25 May 2017

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”), 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”) and Article 9al(5) of Act No. 256/2004 Coll., on Capital Market Undertakings, as amended by Act No. 375/2015 Coll. (hereinafter referred to as the “Capital Market Undertakings Act”), 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, Article 8al(3) of the Act on Credit Unions and Article 9al(3) of the Capital Market Undertakings Act, the countercyclical capital buffer rate for the Czech Republic shall be set at 1.0% 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, credit unions and investment firms pursuant to Article 9aj(1) of the Capital Market Undertakings Act shall apply the rate referred to in point I for the purposes of calculating the combined buffer requirement as from 1 July 2018.

Justification

1. Pursuant to Article 12o(3) of the Act on Banks, Article 8al(3) of the Act on Credit Unions and Article 9al(3) of the Capital Market Undertakings Act, the Czech National Bank (hereinafter 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, Article 8al(1) and (2) of the Act on Credit Unions and Article 9al(1) and (2) of the Capital Market Undertakings Act, the recommendations issued by the European Systemic Risk Board (ESRB) and any indicators that can identify 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 90.6% and the relevant deviation from the long-term trend 1.4 percentage points in 2016 Q4.¹ This value corresponds to a benchmark countercyclical capital buffer rate 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 of 0%. The additional gap², which is calculated in accordance with the ESRB Recommendation (section B, Article 2) and better reflects the specificities of the Czech economy, was 2.8 percentage points in 2016 Q4 and implies a benchmark rate of 0.5%.
3. In reaction to the ESRB recommendation, the Czech National Bank 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 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, Article 8al(3) of the Act on Credit Unions and Article 9al(3) of the Capital Market Undertakings Act.³
4. According to the CNB’s assessment, the Czech economy has shifted further into a growth phase of the financial cycle. This phase is characterised by rapid growth in loans in a number of credit segments.⁴ The faster growth in loans is also affecting property prices, which the CNB currently assesses as being overvalued. Despite tighter macroprudential measures aimed at mitigating risks relating to the residential property market, credit growth in this segment remains strong and conditions are in place for further development of the spiral between property prices and property purchase loans. Owing to higher growth in loans to non-financial corporations in the real estate segment, the vulnerability of the entire sector to adverse developments in this market and to income and interest rate shocks is thus continuing to rise. This assessment implies a need to create a countercyclical capital buffer for exposures located in the Czech Republic. Given the risks to banks’ future profitability identified, banks can be expected to strive to maintain their current profitability levels by increasing the amount of new loans in the economy. This may be reflected in a further rise in property prices above levels consistent with fundamental factors. As a result, systemic risks and the potential for future sharp swings in economic activity are increasing. In accordance with the purpose of the legislation governing the countercyclical capital buffer, it is essential to respond to such developments by raising the countercyclical capital rate. Quantitative approaches based on financial cycle indicator values and a macro stress test of banks which aligns modelled future credit losses with the capital buffer sufficient to cover them confirm the need to raise the buffer rate. A justified rule of thumb to increase the countercyclical capital buffer rate by 0.5 percentage point in each year of the expansionary phase of the financial cycle is in line with this. The final decision on setting the countercyclical capital buffer rate is not based on mechanical application of these approaches.
5. In view of the above assessment, the CNB Bank Board has decided to set the countercyclical capital buffer rate at 1.0%. If credit growth remains high, lending standards ease further and systemic risks relating mainly to the financing of property purchases continue to grow, the CNB will stand ready to increase this buffer rate further.
6. The institutions shall apply this rate as from 1 July 2018 (see statement II).

Effect

This Provision shall take effect on 13 June 2017.

This Provision of a General Nature was published on 13 June 2017.

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 1995–2016 and the Hodrick-Prescott filter with a smoothing parameter (?) of 400,000 were 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 the sector’s gross value added and the minimum level of this ratio achieved in the past eight quarters.

³ The detailed approach of the Czech National Bank (containing all the factors taken into account when setting the countercyclical capital buffer rate) is presented in the thematic article Hájek J., Frait J. and Plašil M. (2017): The Countercyclical Capital Buffer in the Czech Republic, FSR 2016/2017.

⁴ The annual growth rates of loans provided to households for house purchase and for consumption were 9.4%, and 5.0% respectively in March 2017. Loans to non-financial corporations increased by 4.7% year on year in March.