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    BIS Assesses Potential of Capital Buffers to Support Lending in Crisis

    May 05, 2020

    BIS published a bulletin, or brief report, that analyzes the extent to which bank capital buffers can support lending, taking into account the possible COVID-19-induced losses. This three-step analysis first documents the amount of current common equity tier 1 (CET1) capital above the minimum regulatory requirements and assesses the amount that banks could be willing to use under exceptional circumstances (potential buffer). It then estimates how much of these potential buffers would be eroded in an adverse or a severely adverse macro-financial scenario. Finally, it approximates by how much banks could expand lending, depending on how much of the usable buffers they allocate to loans.

    Banks globally entered the COVID-19 crisis with roughly USD 5 trillion of capital above their Pillar 1 regulatory requirements. Yet the amount of capital that banks would be able and willing to use for lending is likely to be substantially lower. The authors assume that banks and supervisory agencies would not be willing to see CET1 ratio of banks fall below 10%, while systemically important banks (SIBs) would also maintain their SIB buffers on top of that. The capital ratio would thus need to remain at least 3 percentage points above the Pillar 1 requirements. The authors refer to the amount of CET1 capital in excess of this benchmark as the banks’ potential buffers, roughly USD 2.7 trillion in total at end-2019—before crisis-related losses occurred.

    The amount of additional lending will depend on how hard banks’ capital is hit by the crisis, on their willingness to use the buffers and on other policy support. The authors take into account two stress scenarios. The first scenario, referred to as the adverse scenario, assumes losses on existing loans comparable to those resulting from the savings and loan crisis in the United States. The second one, the severely adverse scenario, considers losses roughly equivalent to those observed for the great financial crisis. In the adverse stress scenario, banks’ usable buffers would decline to USD 800 billion, which could support USD 5 trillion of additional loans (6% of total loans outstanding). Yet in a severely adverse scenario the corresponding figures would be only USD 270 billion and USD 1 trillion (1.3% of total loans).

    Overall, the analysis shows that—despite the build-up of capital over the past years—usable buffers alone might not be enough to bolster lending should the crisis deepen to a scale comparable to that of the great financial crisis. In such a scenario, policy faces a difficult trade-off. Policymakers need to strike a balance. On the one hand, they need to preserve the banking sector’s lending capacity throughout the crisis. Policy can support the release of buffers and contain the increase of risk-weights—for instance, through credit guarantees. On the other hand, safeguards are needed to prevent capital ratios from falling to levels that could undermine the sector’s resilience—for instance, through capital backstops. Moreover, policy needs to strengthen the incentives for the sector to return to a sustainable path in the medium term, which includes accelerating consolidation and balance sheet repair.

     

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    Keywords: International, Banking, COVID-19, Capital Buffers, CET1, Regulatory Capital, Pillar 1, Basel, BIS

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