Basel Committee guiding principles for operationalisation of sectoral countercyclical capital buffers

On 27th November 2019. the Basel Committee on Banking Supervision published its guiding principles for the operationalisation of sectorial Countercyclical Capital Buffer (‘SCCyB’).

This gives National Authorities the power, in addition to the already implemented Basel III standards on 1st January 2019 (known as ‘CCyB’), to implement an additional buffer of capital in order to protect against future losses, during an economic or credit downturn, in a specific and targeted sector.

The guiding principles have not been included in the Basel Standards, given their flexibility for national implementation.

The Guiding Principles

The seven guiding principles are:

Principle 1: (Objectives): In taking buffer decisions, National Authorities should be guided by the primary objective of the ‘SCCyB’, namely to ensure that the banking sector in aggregate has the capital on hand to help maintain the flow of credit in the economy without its solvency being questioned, when faced with losses related to the unwinding of sectorial cyclical imbalances

Principle 2: (Target segments): National Authorities should define a small number of target segments. These segments should be:
(i) potentially significant from a financial stability perspective; and
(ii) prone to cyclical imbalances. If jurisdictional reciprocity is deemed important, then to facilitate voluntary reciprocation the target segment should be defined in a way that ensures its replicability by jurisdictions other than the home jurisdiction

Principle 3: (Interaction with the ‘Basel III CCyB’): Depending on the situation, National Authorities may wish to either activate the ‘SCCyB’, or the ‘Basel III CCyB’, or to activate both buffers simultaneously. An activation of the ‘SCCyB’ instead of the ‘Basel III CCyB’ should be based on an assessment demonstrating that imbalances are confined to a specific credit segment. When National Authorities consider switching between the ‘SCCyB’ and the ‘Basel III CCyB’ and vice versa, a smooth transition should be ensured. This may include allowing both buffers to be activated simultaneously, in which case National Authorities should ensure that the adding up of buffer rates does not result in double counting of risk

Principle 4: (Indicators for guiding ‘SCCyB’ decisions): National Authorities should identify a transparent set of indicators that have the ability to act as early warning indicators for sectorial imbalances in their home countries and are associated with an increase in system-wide risk in the financial system

Principle 5: (Calibration): National Authorities should ensure an adequate calibration of the tool. An adequate calibration is key that the ‘SCCyB’ can achieve its objectives

Principle 6: (Release): National Authorities’ decision to promptly release the ‘SCCyB’ when sectoral cyclical risks materialise should allow Banks to absorb losses and maintain lending to the real economy. When sectoral cyclical risks do not materialise but are judged to recede more slowly, a gradual release of the buffer may be more appropriate

Principle 7: (Communication): National Authorities should integrate their decision-making on the ‘SCCyB’ into their strategy for communicating their decisions on the ‘Basel III CCyB’. As part of this strategy, they should also establish a transparent communication on their assessment of broad-based versus more targeted cyclical systemic risks in the financial system to key stakeholders and the public (overall risk assessment).

Firms should monitor further updates and developments in this area. If implemented by the Prudential Regulatory Authority (‘PRA’) and Financial Conduct Authority (‘FCA’), Firms will potentially need to reassess their risk weightings, buffer capital and Internal Capital Adequacy Assessment (ICAAP) Process.

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Please Note: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.

Basel Committee guiding principles for operationalisation of sectoral countercyclical capital buffers

Basel Committee guiding principles for operationalisation of sectoral countercyclical capital buffers