The Committee of European Banking supervisors (CEBS) has published a position paper on a countercyclical capital buffer. The paper suggests practical tools for supervisors to assess banks’ capital buffers under Pillar 2. CEBS regards this publication as a contribution to current discussions on pro-cyclicality, but not as yet a final answer.
Buffers should be sufficiently flexible, determined by dialogue between institutions and competent authorities, and not seen as just permanently raising the existing minimum capital requirements. Further, Pillar 2 facilitates flexibility in testing approaches that, subject to some refinements, might also be translated into Pillar 1 tools.
The paper focuses on the cyclicality of credit risk in the banking book of Internal Rating Based (IRB) banks. These are banks which cover a large share of banking assets and whose use of internal models makes them more prone to pro-cyclical effects.
Two options are presented in the position paper: a portfolio level option and (a more granular) rating-grade level option. These mechanisms are based on the differences between the probabilities of default estimated by banks in a recession and as currently applied.
View Position paper on a countercyclical capital buffer, 17 July 2009