The Central Bank of Ireland has said that the countercyclical capital buffer will remain at zero on the basis that aggregate credit conditions remain subdued.
The countercyclical buffer is a capital requirement that applies to banks and investment firms designed to make the banking system more resilient. If credit growth becomes excessive, the countercyclical buffer will increase capital requirements. Essentially, the buffer forces banks to set aside capital in good times to draw down in bad times.
The central bank noted, however, that the property market is the most suggestive of cyclical systemic risks at this time. But it felt that the countercyclical buffer would not offer a “targeted measure to address broader property market developments.”
The move comes as the Bank of England put lenders on notice that they will have to build a special buffer worth £11.4bn over the next 18 months as it tries to make them more resilient to risks such as a burgeoning consumer-credit sector.
The BoE told lenders that it would raise banks’ so-called counter-cyclical capital buffer from zero to 0.5 per cent of UK risk-weighted assets immediately. It also forecast a further 0.5 percentage point rise to 1 per cent by the end of the year as the central bank said the general outlook for the UK’s financial stability is moving to a more normal outlook.
The central bank's Financial Policy Committee reduced its warning level of risks to the system from elevated to standard but warned that there were "pockets" of risk.
“As is often the case in a standard environment, there are pockets of risk that warrant vigilance,” the FPC said in its six-monthly Financial Stability Report on Tuesday. “Consumer credit has increased rapidly. Lending conditions in the mortgage market are becoming easier. Lenders may be placing undue weight on the recent performance of loans in benign conditions.”
The FPC had only deployed the tool once before, a year ago, but then had to quickly revoke it in the wake of the UK’s Brexit vote. The committee added on Tuesday that it would turn off the buffer if risks started to materialise and banks needed to release the capital.
The committee estimates that each 0.5 per cent increase to the buffer equates to a £5.7bn increase in banks’ capital. In addition, it is also boosting another regulatory tool called the leverage ratio by 0.5 per cent to 3.5 per cent, subject to a consultation. The leverage ratio makes banks measure their capital by total assets, rather than measuring those assets by risk. But the FPC kept a caveat in place that lenders did not have to include central-bank reserves that have exploded since the advent of quantitative easing.
The tools are not intended to dampen consumer credit per se, which in the 12 months to April grew by 10.3 per cent. While consumer credit is just one seventh of the size of mortgage lending, the BoE and UK regulators are concerned because write-offs within the sector are still ten times those in mortgage lending, where customers tend to keep up with repayments no matter what.
To tackle the risks from consumer credit, the BoE is bringing forward its analysis of how banks would cope with massive losses in the sector that normally would be a part of lenders' annual stress tests at the end of the year. The BoE's Prudential Regulation Authority and its sister regulator, the Financial Conduct Authority, will also detail in a matter of weeks their expectations of how to treat customers in debt.
The BoE has reviewed earlier caps on mortgage lending, which include a limit on how many mortgages banks can extend when the loan-to-income ratio is above 4.5 per cent. The BoE decided that these caps will now be in place for the foreseeable future.
The bank also warned that financial markets may be overvaluing some corporate bonds and UK corporate real estate assets by failing to fully account for the low and uncertain growth expectations that are driving current low interest rates. The bank raised particular concerns about the valuation of London offices, which it said were currently “well above the range of estimated sustainable valuation levels”.
-(Additional reporting: The Financial Times Ltd 2017)
