The Committee of European Banking Supervisors (CEBS) has published today a Position Paper on a countercyclical capital buffer. The objective of this paper is to outline possible practical tools for supervisors to assess banks' capital buffers under Pillar 2.
The focus on Pillar 2 ensures that buffers are: i) sufficiently flexible, ii) determined as the result of the dialogue between institutions and competent authorities and iii) not seen as simply permanently raising the existing minimum capital requirements. Moreover, Pillar 2 allows for flexibility in testing approaches that, with some refinements, might also be translated into Pillar 1 tools.
This paper focuses on the cyclicality of credit risk in the banking book of IRB banks as these banks cover a substantial share of banking assets and as the use of internal models makes them more prone to pro-cyclical effects.
The mechanisms presented in this paper are based on the differences between the probabilities of default (PDs) estimated by banks in an economic recession/downturn and currently applied PDs. Two options are presented for the calculation of the buffer:
A portfolio level option
A rating-grade level (i.e. more granular) option
In elaborating its concept, CEBS has benefited from input provided by industry experts nominated by CEBS's Consultative Panel and by bilateral meetings held with a sample of major European banks. While not necessarily endorsing the concept and its technicalities, most banks agreed that its rationale is interesting.
Against the background of the ongoing discussions regarding pro-cyclicality at other international fora, CEBS believes that at this stage the options identified and put forward can and should serve as a common CEBS contribution to the discussion, but not yet as a final and complete answer.