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    Randal Quarles of FED Examines Approaches for Setting CCyB

    March 29, 2019

    While speaking at a meeting in New York, Randal K. Quarles, the Vice Chair of Supervision at FED, outlined the approach of FED for setting the countercyclical capital buffer (CCyB) and discussed how CCyB fits within the broad set of efforts to promote financial stability.

    Mr. Quarles emphasized that FED has developed its CCyB framework outlining the objectives of the tool and the factors that would influence the determination of its appropriate level through a process of public consultation. Under the FED policy, the primary objective for activating CCyB is to build financial-sector resilience during periods when the risks to financial stability have risen to meaningfully above normal levels and there is an elevated possibility of potential losses in the banking sector. A secondary objective for using CCyB is its potential to limit the buildup of financial vulnerabilities by slowing the rate of credit expansion. He added that a notable feature of the FED framework is the decision to maintain a 0% CCyB when vulnerabilities are in the normal range. Since the United States has set high, through-the-cycle capital requirements that provide substantial resilience to normal fluctuations in economic and financial conditions, it is appropriate to set the CCyB at zero in a normal risk environment. Thus, the FED presumption has been that the CCyB would be zero most of the time.

    According to Mr. Quarles, assessing the current state of financial vulnerabilities is a critical part of the decision on whether to activate the CCyB. He explained the FED approach is organized around tracking four broad vulnerabilities—namely, asset valuation pressures, household and business debt, funding risk, and financial-sector leverage. FED also considers a number of quantitative indicators—one of which is the credit-to-GDP (gross domestic product) gap proposed in the Basel Committee guidance—that are indicative of potential vulnerabilities. He then outlined the results of the FED assessment of the four financial system vulnerabilities and concluded that these "strike me as being not outside their normal range, which is consistent with a zero CCyB under the Board's framework and is why I supported the Board's decision to keep the CCyB at zero earlier this month." Next, he discussed the international experience with CCyB and explained that he sees three important explanations for differences in the CCyB across countries:

    • One reason is that the different countries face different vulnerabilities. According to national authorities' announcements, the decisions to activate the buffers were generally motivated by credit growth, household debt, and housing prices; in this regard, it is notable that mortgage credit or house prices have expanded rapidly in several countries deploying the CCyB, including Hong Kong and the Nordic countries that have set their CCyB at 2.5%.
    • The availability of alternative tools, such as caps on loan-to-value ratios, for limiting systemic risk may be among the factors influencing the decision to adjust, or not adjust, the CCyB in a number of countries. For example, policymakers in Canada have not activated the CCyB in response to concerns about housing market risks, but they have lowered the maximum loan-to-value ratio for various mortgage products and capped debt-service-to-income ratios. In this regard, it is notable that the set of macro-prudential tools in the United States is limited relative to that in many other countries.
    • Finally, another difference, one that is particular to the United Kingdom, is the framework adopted by the U.K. Financial Policy Committee (FPC) to integrate the CCyB with its structural capital requirements. Under the FPC framework, the CCyB would equal 1% in standard risk conditions. The buffer can be variedboth up and downin line with the changing risks that the banking system faces over time. This approach is an interesting deviation from the idea in the original Basel discussions and the framework adopted in many other jurisdictions, in which structural capital requirements are set at levels aimed to deliver the desired level of resilience, with the CCyB raised to positive values only at times when vulnerabilities are above normal. In practice, the U.K. framework appears to have provided FPC with additional flexibility, as it has adjusted the CCyB with evolving financial risks associated with, for example, Brexit.

    Mr. Quarles added that systems similar to the United Kingdom's, where the CCyB is positive during normal times, may allow policymakers to react more quickly to economic, financial, or even geopolitical shocks that occur amid otherwise normal conditions, without relying on the slow-moving credit aggregates contemplated in the original Basel proposal. Moreover, this setting of the CCyB permits more gradual adjustments in CCyB, especially during high degree of uncertainty about the level of financial vulnerabilities. The approach of the U.K. to setting the CCyB relies on having a high overall level of capital during normal times, but, by "swapping" some portion of static capital for CCyB in reaching that high capital level during normal times, and thus making some of that capital part of a releasable buffer, U.K. policymakers have built in more flexibility to move buffers down in times of stress. Other countries provide additional "data points" in terms of possible ways of approaching the CCyB. In conclusion, he emphasized that the overall capital framework in the United States has been designed to ensure high capital levels without having to activate the CCyB, with the implication being that the bar for activation would be a high one; however, as a result, much of the time there would not be any buffer to reduce if conditions were to precipitously deteriorate. 


    Related Link: Speech


    Keywords: Americas, US, Banking, Basel III, CCyB, Systemic Risk, Financial Stability, Regulatory Capital, Macro-Prudential Policy, FED

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