Provision of a general nature III/2016

on setting the countercyclical capital buffer rate for the Czech Republic No. III/2016

of 1 September 2016

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:

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 October 2017.

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 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. In accordance with the ESRB Recommendation,¹ 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 – in accordance with the ESRB Recommendation – 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. The standardised credit-to-GDP ratio was 76.3% and its deviation from the long-term trend 1.7 percentage points in 2016 Q1. If additional factors were not taken into account, these values would imply setting the 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 at zero.
3. Pursuant to Article 12o(2) of the Act on Banks, Article 8al(2) of the Act on Credit Unions and Article 9al(2) of the Capital Market Undertakings Act, when calculating the countercyclical capital buffer guide the Czech National Bank shall take into account in particular the credit cycle and growth in loans provided in the Czech Republic, changes in the credit-to-GDP ratio, the specificities of the Czech national economy and the recommendations issued by the ESRB.
4. The specific features of the Czech economy include the limited length of the time series of the credit-to-GDP ratio, structural (non-cyclical) breaks caused by the banking crisis in the late 1990s² and trends typical of converging economies. In reaction to the ESRB recommendation, the Czech National Bank has repeatedly emphasised in its publications (particularly the Financial Stability Report) that the method of calculation of the deviation of the credit-to-GDP ratio from its long-term trend is not entirely appropriate for the Czech economy in view of its specificities, and so the decision on the rate cannot be based fully upon it. For this reason, when setting the countercyclical capital buffer rate the Czech National Bank prefers to apply an approach encompassing a wider set of indicators and taking account of the specific features of converging economies.
5. In accordance with the ESRB recommendation,³ the Czech National Bank therefore calculates the additional deviation of the credit-to-GDP ratio from its long-term trend based on a shorter time series which does not include periods with write-offs of non-performing loans (i.e. on the time series starting in 2004). The deviation from the trend calculated in this way was -6.4 percentage points in 2016 Q1 and implies a zero countercyclical capital buffer rate. The Czech National Bank also considers the values of the additional deviation to be only a rough estimate of the position of the economy in the financial cycle and sets the rate on the basis of a comprehensive assessment of the situation based on further relevant indicators which enable it to identify the position in the credit cycle and which may indicate an increase in systemic risk.
6. Credit growth is an important guide for setting the countercyclical capital buffer. The situation on the Czech bank loan market is characterised by increased activity, with credit growth accelerating further in specific segments of the financial system. In 2016 Q2, the annual growth rate of bank loans to non-financial corporations was 6.7% and that to households was 6.4%. For non-financial corporations these levels are above the ten-year average level, whereas for households they are still below it. The annual growth rate of new bank loans to non-financial corporations (as measured by the three-month moving average) stood at -29.0% in 2016 Q2. Data on genuinely new loans to non-financial corporations show that the negative growth was due primarily to a drop in short-term financial loans (-39.2% in 2016 Q2). The flow of longer-term investment loans also declined (-16.0% in 2016 Q2). Households, by contrast, recorded annual growth in new bank loans (as measured by the three-month moving average) of 9.9%, well above the ten-year average. Particularly high credit activity is being observed for loans to households secured by residential property. The flow of genuinely new loans (net of refixed and refinanced loans) in this segment rose by 12.7% year on year in 2016 Q2. Growth in genuinely new consumer credit also increased (to 28.5% in 2016 Q2).
7. When setting the countercyclical capital buffer rate, the Czech National Bank also takes into account additional indicators of potential growth in systemic risk. Credit standards are having a procyclical effect. They have been easing since the start of 2014. The latest bank lending survey⁴ reveals that standards have eased the most in the segments of non-financial corporations and consumer credit to households. The rate of growth of household debt has been increasing since 2014 Q4 and reached only slightly lower levels than the ten-year average in 2016 Q1. The intensifying growth in cyclical risks is also being fostered by residential property prices, whose annual growth rate has exceeded the ten-year average since the second half of last year (4.5%). In these conditions, the risk of occurrence of a spiral between property price growth and growth in loans used to finance property purchases therefore persists. The combination of an economic recovery and very low lending interest rates, which is being reflected in a rise in investor optimism about both residential and commercial property, is a risk factor for the occurrence of this spiral.
8. Overall, the Czech National Bank’s assessment of the aforementioned indicators is that the Czech economy is currently continuing in an upward phase of the financial cycle. This is characterised by robust growth in loans in a number of credit segments accompanied by an easing of credit standards. A similar picture is provided by the aggregate indicator of the financial cycle combining the above indicators and taking into account their correlation. The strong growth in new loans to households is increasing the vulnerability of the entire sector to sudden economic swings and is simultaneously fostering growth in residential property prices, which the CNB currently assesses as being slightly overvalued. This assessment implies a need to create a countercyclical capital buffer for exposures located in the Czech Republic. As there has been no change in cyclical risks indicating significant growth in systemic risk since the last decision on the setting of the countercyclical buffer rate was made in June 2016, the CNB is leaving the countercyclical capital buffer rate for exposures located in the Czech Republic at the current level of 0.5% for the time being. However, if credit growth remains high, credit standards ease further and investor optimism continues to grow, the CNB will stand ready to increase this buffer rate further.
9. The institutions shall apply this rate as from 1 October 2017 (see statement II).

This Provision shall take effect on 16 September 2016.

This Provision of a General Nature was published on 16 September 2016.

¹ Recommendation of the European Systemic Risk Board of 18 June 2014 on guidance for setting countercyclical buffer rates (ESRB/2014/1).

² A decrease in the stock of credit in the late 1990s and early 2000s, due to write-offs of non-performing loans from banks’ balance sheets, had a significant effect on the estimate of the long-term trend of the credit-to-GDP ratio used for the calculation of the buffer guide.

³ Recommendation B(1).

⁴ CNB (2016): Bank Lending Survey, July 2016.