Provision of a general nature II/2023

of 1 June 2023

on setting the countercyclical capital buffer rate for the Czech Republic No. II/2023

Pursuant to Article 12o(6) of Act No. 21/1992 Coll., on Banks, as amended (hereinafter referred to as the “Act on Banks”) and Article 8al(6) 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 (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:

1. Pursuant to Article 12o(4) of the Act on Banks and Article 8al(4) of the Act on Credit Unions, the countercyclical capital buffer rate for the Czech Republic shall be set at 2.25% 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.
2. Entities pursuant to Article 12m(1) of the Act on 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 2023.

Justification

1. Pursuant to Article 12o(4) of the Act on Banks and Article 8al(4) of the Act on Credit Unions, the Czech National Bank (hereinafter referred to as the “CNB”) shall assess the degree of cyclical systemic risk, based on which it may set or amend the countercyclical capital buffer rate for the Czech Republic, taking into account the countercyclical capital buffer guide calculated pursuant to Article 12o(2) and (3) of the Act on Banks and Article 8al(2) and (3) 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(2) 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 83.1% and the relevant deviation from the long-term trend -8.6 percentage points in 2022 Q4.^[1] This value pursuant to Article 12o(2) of the Act on Banks and Article 8al(2) 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 economy in the Czech Republic, was 0 percentage points in 2022 Q4 and implies a benchmark rate of 0%.
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(4) of the Act on Banks and Article 8al(4) of the Act on Credit Unions.^[3]
4. The financial cycle indicator (FCI) decreased in 2022 Q4 to levels well below the local peak reached at the end of 2021. The decline in the indicator was due mainly to a slowdown in growth in new loans to households, slower property price growth and a decline in the debt of households and corporations.
   Only slightly slowing drawdown of bank loans by non-financial corporations and a drop in the interest rate spread for loans to households dampened the speed of decline of the indicator. Overall, the IFC indicates that the extent of newly accepted cyclical risks in the domestic banking sector’s balance sheets is significantly subdued. This is also suggested by the revised IFC, which adjusts the original IFC for nominal developments in the economy and also reflects the relatively significant share of euro loans provided to domestic non-financial corporations in the calculation of the interest rate spread. Overvaluation of apartment prices for the median household remained very elevated at 57% in 2023 Q1, despite a significant cooling of growth in prices of residential property. In particular, net new loans to households for house purchase slowed significantly, dropping in volume by around 66% year on year in 2023 Q1. This was accompanied by declining year-on-year growth rates of the stock of loans to households and non-financial corporations, which were below the long-term averages at the end of 2023 Q1 following a period of significantly above-average growth.^[4] The CNB continues to view the total amount of cyclical risks accumulated in banks’ balance sheets as high. Low provisioning and the level of the ratio of provisions to total loans may meanwhile indicate that the banking sector may not be sufficiently prudent in assessing credit risks. The potential unexpected cyclical credit losses would be CZK 26.7 billion based on a method emphasising risks accumulated in the previous growth phase of the financial cycle. Cyclically lowered risk weights in the loan portfolios of banks applying the IRB approach also remain a source of systemic risk. A deterioration in risk parameters as a result of significantly adverse cyclical effects would lead to a rise in risk weights and indirectly also in the capital requirement in absolute terms. This rise should also be covered by the countercyclical capital buffer. The capital needed to cover the fall in the capital ratio as a result of the potential cyclical rise in risk weights amounts to around CZK 25.0 billion according to the CNB’s estimates. The total additional capital needed to cover unexpected cyclical credit losses and the growth in risk weights thus amounts to CZK 51.7 billion, which corresponds to a countercyclical capital buffer rate of 2%. However, the partially persisting geopolitical and economic uncertainty associated with future developments is creating potential for faster and more substantial materialisation of cyclical risks than the baseline estimate assumes. For these reasons, the CNB left the countercyclical capital buffer rate above the levels indicated by quantitative approaches.
5. Based on the above assessment, the CNB Bank Board has decided to set the countercyclical capital buffer rate at 2.25%, which is the level necessary to ensure that the banking sector is resilient to these risks. Should the cyclical risks continue to disappear naturally from the banking sector’s balance sheets, the CNB is ready to lower the countercyclical capital buffer rate gradually further. Should the economic situation worsen significantly and significant unexpected credit losses form in the domestic banking sector, the CNB is ready to lower the buffer rate more significantly or release the buffer fully in order to foster smooth lending to the real economy.
6. Given the expected further evolution of the financial cycle in the quarters ahead and the related expected persisting downturn in the extent of newly accepted cyclical risks in the domestic banking sector’s balance sheets, the CNB does not expect the countercyclical capital buffer rate to increase over the next 12 months.
7. 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.
8. The previously issued provisions of a general nature on setting the countercyclical capital buffer rate for the Czech Republic shall lose legal effect upon the publication of this provision of a general nature.
9. The countercyclical capital buffer rate set by this provision of a general nature shall apply until another provision amending this rate is issued.

Effect

This Provision shall take effect on 2 June 2023.

This provision of a general nature was published on 2 June 2023.

^[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 Q1–2022 Q3 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 rate of bank loans provided to households for house purchase was 5.0% as of 31 March 2023. The annual growth rate of bank loans to households for consumption was 9.3%. This figure was affected by a one-off increase in the stock of loans for technical reasons – loan reclassification – in November 2022. Bank loans to non-financial corporations increased by 3.8% year on year as of 31 March 2023.