Minutes of the CNB Bank Board meeting on financial stability issues on 16 June 2022
Present at the meeting: Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Vojtěch Benda, Oldřich Dědek, Tomáš Holub, Aleš Michl.
The meeting opened with a presentation given by the Financial Stability Department on the main conclusions of Financial Stability Report – Spring 2022. The presentation focused mainly on the position of the Czech economy in the financial cycle, developments in the financial sector in recent months, risks to the financial sector going forward, especially those connected with Russia’s invasion of Ukraine and the energy crisis, the resilience of the banking sector to adverse shocks and the need for the CNB’s macroprudential policy to respond to the risks associated with mortgage lending and growth in housing prices. The Bank Board first discussed the countercyclical buffer (CCyB) rate and the capital buffers needed to cover the accumulated and newly emerging risks in the balance sheets of the domestic banking sector. It then assessed the mortgage market and residential property market in detail and decided on the settings of macroprudential tools targeted at related risks.
The countercyclical buffer (CCyB) rate
The part of the Financial Stability Department’s presentation on the CCyB emphasised that, according to the aggregate financial cycle indicator and other indicators, the domestic economy had been close to the peak of the financial cycle at the end of 2021. So far this year, it had probably moved down slightly. Quantitative approaches to determining the CCyB rate implied a need to set the rate at 2%, but the Financial Stability Department proposed leaving it at 2.5%. Its key argument was the greatly increased volume of previously accepted cyclical risks in the banking sector’s balance sheet, with the present uncertainty regarding future economic developments creating potential for those risks to materialise extensively.
The board members agreed that it was not desirable to lower the CCyB rate below the pending 2.5% rate at the moment, because additional risks on top of the existing ones were entering banks’ balance sheets via relatively rapid credit growth, which had been well above the historical averages in the main credit segments in the first quarter of 2022. There was also a consensus that it was necessary to take into account the current geopolitical and macroeconomic uncertainties, which were creating room for sudden and strong materialisation of previously accepted risks. Governor Jiří Rusnok said that the CCyB rate also needed to reflect the fact that the CNB, like some other macroprudential authorities in the EU, had embraced a 1% cyclically neutral CCyB rate. Some of the board members regarded it as important that 2.5% was not the ceiling on the CCyB rate and that the regulatory framework permitted a higher rate to be set in the event of sharply rising risks. Oldřich Dědek said it would become relevant to discuss lowering the CCyB rate if the economy switched to a downward phase of the financial cycle. Tomáš Nidetzký added that given banks’ current capitalisation and profitability, leaving the CCyB rate at 2.5% would not represent a constraint on banks, even if such a situation might arise in the future. Tomáš Holub was in favour of leaving the CCyB rate at 2.5%, as the economy was close to the peak of the financial cycle and it was desirable for it to move down from the peak in an orderly way, to which the interest rate increases would also contribute.
The board members also agreed that it was vital, as in the past, to respond flexibly to changes in market conditions. Should the economic situation worsen and the domestic banking sector incur significant unexpected credit losses, the Bank Board will therefore be ready to lower the CCyB rate or release the buffer fully to support banks’ ability to lend to the real economy without interruption.
A large part of the Bank Board’s discussion was devoted to the results of stress tests of the financial sector and parts of the real economy. Vojtěch Benda noted that despite the highly stressful nature of the adverse scenario, the evolution of the economy in the coming years could be even worse in reality. It would therefore be essential to continuously assess the size of the stress in relation to the relevant scenario and respond quickly to any deviations. This applied particularly to the results of the stress tests of households with a mortgage loan, which were relatively optimistic. Vojtěch Benda was also in favour of developing the stress testing of climate risks and taking account of geopolitical risks in tests with a longer horizon. Marek Mora also felt it was desirable to publish the results of a stress test incorporating the impact of climate risks in Financial Stability Report – Autumn 2022. Oldřich Dědek added that although the stress test results had demonstrated the resilience of the domestic financial sector even in the adverse scenario, they did not hide the fact that many measures would have to be adopted at the level of individual institutions.
Oldřich Dědek and Marek Mora emphasised the risks associated with the persisting very low provisioning, which could make the banking sector vulnerable. It was important to take this risk into account in the settings of macroprudential instruments and in the CNB’s supervisory work. In the discussion, it was said that this situation prevailed in virtually all European countries and that the IFRS 9 accounting standard, applied since 2018, had not contributed very much to increasing the creation of provisions in favourable phases of the cycle. Oldřich Dědek and Aleš Michl also pointed to the growing risk of euroisation of loans provided to non-financial corporations and to the need to assess this trend from the perspective of the CNB’s entire set of policies.
After discussing the cyclical sources of systemic risk, the stress test results and the outlook for the capitalisation of domestic banks, all the board members present voted to leave the CCyB rate for exposures located in the Czech Republic unchanged at 2.5%.
Limits on mortgage lending ratios
The second part of the Bank Board’s meeting was focused on risks connected with mortgage lending and the residential property market. According to the presentation given by the Financial Stability Department, the spiral between debt financing of property purchases and rapidly rising property prices had continued to intensify during 2021 and partially in the first quarter of 2022. At the end of 2021, apartment prices for median-income households had been around 40% higher than the level consistent with their incomes and with the mortgage interest rates required by the market. Apartments purchased as an investment had been recording roughly the same high levels of overvaluation. The property price projection used for stress-testing purposes expected year-on-year growth in house prices to remain positive in 2022 if the CNB’s spring macroeconomic forecast materialised. However, the rate of growth of prices would slow sharply and would stay subdued in 2023. There was meanwhile potential for a stronger price correction in the event of worse-than-forecasted macroeconomic developments. The CNB was also expecting the amount of new loans to decline significantly year on year in 2022 due to the previous year’s high base, the increase in interest rates, the sharp growth in energy prices and other costs of living, and the worse economic outlook. Based on an evaluation of the detailed data available to the CNB as of February 2022, mortgage lending standards had remained generally relaxed. This was evidenced by steady growth in the share of loans with high DSTI ratios. In light of the greatly elevated systemic risks associated with mortgage lending, the Financial Stability Department recommended leaving the upper limits on credit ratios at the levels approved by the CNB Bank Board in November 2021 and effective since 1 April 2022.
The board members agreed that the risk profile was essentially unchanged. Data capturing the effects of the current limits and offering a more accurate picture of the risks would be available at the end of this year. Only after this data had been assessed would it be possible to respond by changing the measures. There was also a consensus that the DSTI limit, which was becoming the most constraining one, had been set at a relatively high level, i.e. it had anticipated some growth in interest rates. Tomáš Nidetzký said it was desirable not to make changes to instruments of this type too often, because every change was costly in terms of adjustment for market participants and gave rise to a risk of arbitrage. In his opinion, monetary policy – which, like macroprudential policy, was acting to suppress the risks – was also allowing the current credit ratio limits to be preserved. Oldřich Dědek also felt that changing the credit ratio limits just before they took effect could be interpreted as excessive activism.
Tomáš Nidetzký pointed to the need to constantly raise awareness about the concept of house price overvaluation. It would be better to refer to this indicator as the percentage degree misalignment between current house prices and historical norms. In particular, it was vital to explain that the percentage degree of overvaluation cannot be interpreted as a forecast that house prices will fall in future years. In a discussion of the future trend in house prices, Tomáš Holub pointed to the risk that, with inflation expectations rising, the incentive to buy property as protection against inflation could increase in the absence of a firm monetary policy response. In such case, the projected downturn in house price growth would not necessarily materialise in full. According to Tomáš Holub, the likelihood of this was being increased by the none-too-constraining LTV limit, which he felt was “borderline” when apartment prices were 40% overvalued. On the other hand, he believed it was highly likely that the DSTI limit would become strongly constraining in the event of a sharp rise in client rates. It could then become relevant to discuss whether to relax the limit on this ratio at a time of high interest rates or to apply a DTI limit only. Marek Mora said he felt that the effect of the rise in interest rates on house price dynamics would be stronger than that of the limits on mortgage ratios. In his view, more balanced taxation of home ownership would also help house prices to converge to economic fundamentals in the future. The present structure of that taxation could be one of the reasons why house prices in the Czech Republic had been growing the fastest in the developed world in recent years. He was also in favour of assessing whether the LTV limit was set appropriately with respect to the growth and overvaluation of house prices.
In the next part of the discussion, Tomáš Nidetzký said that the CNB should continue to debate whether to apply the sectoral systemic risk buffer (sSRB) to react to the rising risk of concentration of bank loans in financing the purchase and construction of residential and commercial property. The advantage of the sSRB is that, unlike the CCyB, it does not have an across-the-board impact and can be set so as to reflect the composition of specific banks’ balance sheets. In the subsequent discussion, it was said that, partly due to the CNB’s supervision of banks, the risk rates on the relevant loans derived from IRB modelling approaches had almost stopped decreasing. Setting an sSRB requirement therefore did not seem immediately necessary at the moment. The use of this instrument was nonetheless one possible response in the future. The CNB would also support the existing proposals to simplify the use of the sSRB in the ongoing review of the EU’s macroprudential rules.
After discussing the relevant item, all the board members present voted to leave the upper limit on the LTV ratio at 80% (90% for applicants under 36 years), the upper limit on the DTI ratio at 8.5 times net annual income (9.5 times for applicants under 36 years) and the upper limit on the DSTI ratio at 45% of net monthly income (50% for applicants under 36 years).
Author of the minutes: Jan Frait, Executive Director, Financial Stability Department