Measuring and mitigating cyclical systemic risk in Ireland: The application of the countercyclical capital buffer

Following a number of years where the activation of the countercyclical capital buffer was limited, it is now becoming an increasingly relevant and actively used macroprudential policy tool across Europe. Against this background, this Note describes the high-level approach taken by the Central Bank of Ireland in setting the countercyclical capital buffer rate applicable to Irish exposures. In addition, the Note discusses issues around the identification of cyclical systemic risk in Ireland, and in particular the role of the credit-to-GDP gap as an appropriate reference indicator for countercyclical capital buffer rate decisions. The Note introduces work within the Central Bank of Ireland to develop a potential alternative reference indicator for informing countercyclical capital buffer decisions. In particular, an alternative measure of the national credit gap which looks to account for structural shifts in the economy and informs the estimation of the cycle through additional variables. This semi-structural measure of cyclical systemic risk addresses some of the main drawbacks of purely statistical methods such as excessively persistent trends, a feature that is particularly desirable in post-crisis circumstances.