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How usable are capital buffers?

Author

Listed:
  • Leitner, Georg
  • Dvořák, Michal
  • Magi, Alessandro
  • Zsámboki, Balázs

Abstract

This paper analyses banks’ ability to use capital buffers in the euro area, taking into account overlapping capital requirements between the risk-based capital framework and the leverage ratio capital framework from 2016 to 2022. This analysis is the first to quantify buffer usability in multiple jurisdictions and across various bank types, identify key drivers of buffer usability and assess the impact of various policy measures using longer time series. The paper shows that while both risk-based and leverage frameworks play a key role in enhancing the resilience of the banking system and ensuring financial stability, their simultaneous application creates interactions that may affect the functioning of capital buffers. In this regard, we investigate to what extent banks could have drawn down regulatory capital buffers in the risk-based framework without breaching current leverage ratio requirements, which is in line with the approach to buffer usability taken in ESRB (2021b). We show that buffer usability was partially constrained in the period examined and is expected to remain so under the current regulatory framework and if risk weight densities (RWDs) remain low. This finding indicates that the leverage ratio constitutes an effective backstop to the risk-based framework, both as regards minimum requirements and capital buffers. Limited buffer usability was identified especially for global systemically important institutions (G-SIIs) that rely largely on internal modelling approaches to calculate risk-based capital requirements, leading to comparably low risk weights and making the leverage ratio relatively more binding. Adding to previous contributions, we find that banks’ ability to use capital buffers fluctuated over time, generally increasing before 2019 and decreasing after the start of the coronavirus (COVID-19) pandemic, with substantial heterogeneity across countries. Furthermore, we provide new insights into the relationship between the RWD of a bank and its buffer usability and find that there is a critical RWD range between 25% JEL Classification: G21, G28

Suggested Citation

  • Leitner, Georg & Dvořák, Michal & Magi, Alessandro & Zsámboki, Balázs, 2023. "How usable are capital buffers?," Occasional Paper Series 329, European Central Bank.
    • Handle: RePEc:ecb:ecbops:2023329
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    References listed on IDEAS

    as
    1. Leo Haan & Jan Kakes, 2020. "European banks after the global financial crisis: peak accumulated losses, twin crises and business models," Journal of Banking Regulation, Palgrave Macmillan, vol. 21(3), pages 197-211, September.
    2. Andreeva, Desislava & Bochmann, Paul & Couaillier, Cyril, 2020. "Financial market pressure as an impediment to the usability of regulatory capital buffers," Macroprudential Bulletin, European Central Bank, vol. 11.
    3. Falagiarda, Matteo & Prapiestis, Algirdas & Rancoita, Elena, 2020. "Public loan guarantees and bank lending in the COVID-19 period," Economic Bulletin Boxes, European Central Bank, vol. 6.
    4. Budnik, Katarzyna & Dimitrov, Ivan & Groß, Johannes & Jančoková, Martina & Lampe, Max & Sorvillo, Bianca & Stular, Anze & Volk, Matjaz, 2021. "Policies in support of lending following the coronavirus (COVID 19) pandemic," Occasional Paper Series 257, European Central Bank.
    5. Allen, Linda & Saunders, Anthony, 1992. "Bank window dressing: Theory and evidence," Journal of Banking & Finance, Elsevier, vol. 16(3), pages 585-623, June.
    6. José Abad & Antonio I Garcia Pascual, 2022. "Usability of Bank Capital Buffers: The Role of Market Expectations," IMF Working Papers 2022/021, International Monetary Fund.
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    More about this item

    Keywords

    banking regulation; buffer usability; capital buffers; leverage ratio; macroprudential policy;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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