IMF published a working paper on credit cycle and capital buffers in Central America, Panama, and the Dominican Republic (CAPDR). The paper reviews the financial and credit developments in CAPDR countries, provides a comparative assessment of the credit cycle in the region, and discusses the possible use of countercyclical capital buffer (CCyB) in the region as a tool to enhance the resilience of the banking system.
The paper describes the current state of financial developments in the region, highlighting that banks are well-capitalized, with good credit quality and a solid deposit base. Banking systems in CAPDR have capital ratios comfortably above the minimum requirements while NPLs are low—ranging from about 1% of total loans in Nicaragua to about 2.5% in Honduras and Guatemala—and typically over-provisioned. Credit is mostly financed by costumer deposits, which account, on an average, for 80% of total (non-interbank) loans. The paper then presents the methodology used to estimate the credit-to-GDP gap, starting from the approach proposed by BCBS, which is adjusted to account for the fast credit growth environment of developing economies. Next, the paper presents the empirical analysis that estimates the credit gap, tests its ability to signal impeding financial distress for each country in the region, and discusses implications for setting CCyB and capital adequacy requirements. In the paper, the authors estimate the credit cycle in CAPDR and find that the credit gap is a powerful predictor of systemic vulnerability in the region. They also simulate the activation of the Basel III CCyB and discuss the macro-prudential policy implications of the results, arguing that countercyclical macro-prudential policies based on the credit gap could prove useful to enhance the resilience of the region’s financial sector.
However, the authors conclude that activation of macro-prudential instruments should be informed by the development of other macro-financial variables and by expert judgment. It is recommended that formalizing an analytical framework to assess the applicability of CCyB in CAPDR should be considered to enhance the stability of the banking system. The signaling power of the credit gap suggests that authorities could consider introducing CCyB in their policy toolkit. CCyB would be a useful policy instrument to strengthen the resilience of the banking system through the financial cycle and limit the procyclicality of lending. Decisions on the CCyB should be based on a deep assessment of the credit developments. Qualitative information and judgment should also be used to analyze the changes in lending standards and credit conditions. Ultimately, the policy makers need to ensure that any expansion in credit is healthy and understand the reasons behind any credit contraction. Credit deepening must go hand-in-hand with measures that facilitate a healthy credit expansion such as effective legal frameworks for the creation, mobilization, and realization of collateral and effective insolvency proceedings.
Related Link: Working Paper
Keywords: Americas, Banking, Credit Cycle, Basel III, CCyB, Macro-Prudential Policy, Capital Adequacy, Systemic Risk, CAPDR, IMF
Previous ArticleEBA Publishes Handbook on Valuation for Bank Resolution
EBA published a report analyzing the impact of the unwind mechanism of the liquidity coverage ratio (LCR) for a sample of European banks over a three-year period, from the end of 2016 to the first quarter of 2020.
In response to questions from a member of the European Parliament, the ECB President Christine Lagarde issued a letter clarifying the possibility of amending the AnaCredit Regulation and making targeted longer-term refinancing operations (TLTROs) dependent on the climate-related impact of bank loans.
IASB started the post-implementation review of the classification and measurement requirements in IFRS 9 on financial instruments and added the review as a project to its work plan.
FSB published a report that examines progress in implementing policy measures to enhance the resolvability of systemically important financial institutions.
EBA published a report on the benchmarking of national loan enforcement frameworks across 27 EU member states, in response to the call for advice from EC.
FSB published a letter from its Chair Randal K. Quarles, along with two reports exploring various aspects of the market turmoil resulting from the COVID-19 event.
RBNZ launched a consultation on the details for implementing the final Capital Review decisions announced in December 2019.
The Trustees of the IFRS Foundation, which are responsible for the governance and oversight of IASB, have announced the appointment of Dr. Andreas Barckow as the IASB Chair, effective July 2021.
HKMA issued a letter to consult the banking industry on a full set of proposed draft amendments to the Banking (Capital) Rules for implementing the Basel standard on capital requirements for banks’ equity investments in funds in Hong Kong.
ESRB published an opinion assessing the decision of Swedish Financial Supervisory Authority (FSA) to extend the application period of a stricter measure for residential mortgage lending, in accordance with Article 458 of the Capital Requirements Regulation (CRR).