Key Aspects of Macroprudential Policy - Background Paper

Regulatory Capital Requirements and Capital Buffers: An Examination of the Australian Banking Sector

As per the 15th progress report on adoption of the BASEL regulatory framework, published in October 2018 by Basel Committee on Banking Supervision, 26 member jurisdictions now have final rules in force for CCCB. In India, the final rules on CCCB came into force from 5th Feb, 2014; however, the buffer has not been activated by RBI till now as in its assessment, the Credit to GDP gap and other indicators currently do not warrant activation of the countercyclical capital buffer (CCCB). The Basel III regulatory framework for more resilient banks and banking systems, released in December 2010, had introduced the CCCB aimed at strengthening banks defense against the build-up of systemic vulnerabilities. The CCCB is a pre-emptive measure that requires banks to build-up capital gradually as imbalances in the credit market develop. The primary objective of CCCB is to avoid any banking industry stress resulting from wide fluctuations in the credit cycle using the credit-to-GDP gap. In doing so, it raises the cost of capital for banks resulting in moderation of credit demand as well as dissuasion of banks from participating in binge credit growth during the buildup phase itself. The authors have calculated the credit-to-GDP gap (which has been accepted as the main Indicator) for India using the available data and conclude that the buffer guide has historically worked as a reliable EWI in the Indian context. The authors have also concluded that while CCCB is an instrument to protect banks from the bust phase of the financial cycle, it is not an instrument to manage the financial cycle, even if it may potentially have a smoothing impact. An important implication of implementing CCCB using the credit-to-GDP gap as the main indicator for banks and EMEs is that it may hinder beneficial financial deepening, if it is used to actively manage the financial cycle. The authors recommend including the attribution of the Credit-to-GDP GAP w.r.t., the changes attributable to GDP growth, as well as attributable to changes in credit growth in the decision making process to activate CCCB.

We evaluate how a country’s governance structure for macroprudential policy affects its implementation of Basel III macroprudential capital buffers. We find that the probabilities of using the countercyclical capital buffer (CCyB) are higher in countries that have financial stability committees (FSCs) with stronger governance mechanisms and fewer agencies, which reduces coordination problems. These higher probabilities are more sensitive to credit growth, consistent with the CCyB being used to mitigate systemic risk. A country’s probability of using the CCyB is even higher when the FSC or ministry of finance has direct authority to set the CCyB, perhaps because setting the CCyB involves establishing a new macro-financial analytical process to regularly assess systemic risks and allows these new entities to influence the process. These results are consistent with elected officials creating the FSCs with the strongest governance and fewer agencies for functional delegation reasons, but most FSCs are created for symbolic political reasons.

Financial system stability is a crucial element for the sustainability of the national economy. Imbalances in the financial sector, particularly those arising from credit growth that is not aligned with economic capacity, can lead to systemic risk. In response to these risks, Bank Indonesia has implemented macroprudential policies through instruments such as the Macroprudential Intermediation Ratio (RIM) and the Countercyclical Capital Buffer (CCyB). This study aims to analyze how RIM and CCyB contribute to maintaining financial system stability in Indonesia by utilizing national data from 2010 to 2024. Financial system stability is measured using the Non-Performing Loan (NPL) ratio in the banking sector. The analytical method employed is time series regression using the Ordinary Least Squares (OLS) approach, complemented by stationarity tests and classical assumption tests. The results indicate that RIM has a significant negative effect on NPL, while CCyB also exhibits a negative relationship, although with a lower level of significance. These findings suggest that synergy in macroprudential policies is essential to strengthen banking sector resilience and maintain the stability of Indonesia’s financial system.

We study the impact of positive and negative macroeconomic U.S. and European news announcements in different phases of the business cycle on the high-frequency volatility of the EUR/USD exchange rate. The results suggest that news effects depend on the state of the economy. In general, news increases volatility more in good times than in bad times. News effects are also asymmetric with respect to sign: negative news increases volatility more in good times than in bad times, while there is no difference between the volatility effects of good news in bad and good times.

Objective: This study aims to investigate how banks determine their capital buffer. Return on Equity (ROE), Non-Performing Loans (NPL), Capital Buffer Lag (BUFFt-1), Loan to Total Assets (LOTA), and Income Diversification (IDIV) are some of the variables examined in this study. Research Design & Methods: Purposive sampling was used to collect samples for this study. It was 20 of the 42 conventional commercial banks that were listed on the Indonesia Stock Exchange in 2012-2016. In this study, multiple regression analysis was used, as well as the ordinary and two-stage least squares methods. Findings: The results of this study have shown that the capital buffer has a negative impact on return on equality (ROE) and income diversification (IDIV). The capital buffer was affected by Lag of Capital Buffer. This research examines how a bank can make a profit from the negative impact of ROE. Based on the results of the tests, the Indonesian Bank has not pursued the highest possible capital buffer. Implications & Recommendations: Companies will use their profit to further profitable activities when they fulfill a minimum capital buffer requirement. Contribution & Value Added: The results of this study try to give an idea for the management of capital and capital buffers and to determine the ideal strategy for investors and banks to meet the Basel and Government regulation. This research tries to add insight into the internal factors that determine capital buffers at conventional commercial banks in Indonesia, as well as research references in the field of financial management, particularly capital buffers.

PurposeThe purpose of this paper is to assist bank regulators in Africa who are currently considering the implementation of Basel III countercyclical capital buffer (CCB) requirement.Design/methodology/approachUsing a panel data set of 129 commercial banks operating in 14 African countries over the period 2004–2014, this paper estimates the system generalized method of moments regression to examine the impact of business cycle on banks’ regulatory capital buffers and attempts to identify the influence of bank revenue diversification, market power and cost of funding (CF) on bank regulatory capital buffers. It further carries out some robustness analyses using a panel data set of 257 commercial banks in 23 African countries over the period 2004–2014.FindingsThe results show that higher regulatory capital buffers are associated with higher market power, higher revenue diversification and higher CF. Additionally, the results show significant evidence of procyclical behavior of bank capital buffers (BUFs) in the sampled countries.Practical implicationsThe results of this study suggest that African banking systems are not exposed to contagion and systemic risks arising from countercyclical movements of BUFs to the real economy. Therefore, this study does not support the implementation of the Basel III CCB requirement in the sampled African countries.Originality/valueConsidering that the results of existing studies on the cyclical behavior of BUFs are inconclusive, there is value in studying the cyclical movements of bank regulatory capital buffers in a set of countries that has not been analyzed before. Toward this direction, this is the first empirical study focusing on the cyclical behavior of bank regulatory capital buffers in Africa. Besides examining the cyclical behavior of bank regulatory capital buffers, this paper further investigates the effects of bank revenue diversification, market power and CF on bank regulatory capital buffers.

Adding Fuel to the Fire Sales: Banks, Capital Regulation, and Systemic Risk

This article applies the generalized method of moments (GMM) to examine the relationship between capital buffer, risk and efficiency adjustments over the macroeconomic cycles. Using a panel dataset of 32 Bangladeshi commercial banks over the period from 2000 to 2014, we find an inverse relationship between the business cycle and capital buffers, while a positive relationship between the business cycle and bank risk. These findings support the implementation of countercyclical capital buffers in Basel III Accord to ensure bank safety during economic downturns. We also observe that the bank efficiency positively responds to macroeconomic fluctuations. While examining the impact of capital buffers on bank behaviour, we find that low buffer banks raise the level of capital buffers and improve the efficiency over time. In contrast, high buffer banks incline to raise investment in risky projects by deterioration of capital ratios during economic upturns. In this case, high buffer banks in developing countries should take risk and efficiency issues into great consideration and force low capitalized banks to follow the Basel III guidelines more stringently to adjust capital buffers, risk and efficiency with macroeconomic bounce. Also, developing countries, regulatory bodies are adopting and implementing Basel guidelines slowly, and thus it has volunteer impact on the buffer, risk and efficiency adjustments. So the regulatory bodies should be adapted the global financial changes that will be enhanced country’s financial market.

Countercyclical prudential tools in an estimated DSGE model

This thesis investigates three comprehensive research issues in the context of five selected Association of Southeast Asian Nations (ASEAN) banking markets (Indonesia, Malaysia, the Philippines, Thailand and Vietnam) during the period 1998-2010. This study is motivated by the extensive restructuring efforts that took place in the aftermath of the Asian Financial Crisis (AFC) which has shaped the banking behaviour in ASEAN countries to enable them to sustain their financial systems’ stability. As a result of the crisis, banks adopted several strategies in response to various structural and policy changes and, therefore, there were vast effects on banks’ behaviour following the AFC and pre and post the Global Financial Crisis (GFC) period. The first empirical study of this thesis investigates the impact of market power on credit risk, revenue diversification and bank stability. The findings suggest that bank market power is positively associated with credit risk and revenue diversification. Nevertheless, these associations diminished during the GFC, implying that banks with greater market power were able to better manage their non-performing loans during the crisis period. Bank stability, however, is not associated with market power. Instead, it is found to be a negative function of state-ownership, asset composition and banking freedom. Overall, even though ASEAN banks with greater market power have higher credit risk, they are more diversified thus leaving their overall bank risk unaffected. The second empirical study examines the association between net interest margin, revenue diversification and risk-adjusted profitability. The findings suggest a two-way association between net interest margin and revenue diversification. The results denote a significant inverse relationship in the period 1998-2002, indicating subsidisation between interest and fee-generating business in the aftermath of the crisis. For the latter part of the sample (2003-2010), a positive association has been reported for net interest margin and revenue diversification implying that non-interest income does not necessarily increase with the detriment of the net interest margin. The findings reveal that diversification benefits exist for the same sub-sample period i.e. after the Basel II regulations came into force around 2003. The results also suggest that in the aftermath of both crises, risk adjusted profitability declined as banks had limited scope to diversify their sources of revenue. Overall, ASEAN banks have evolved over time, moving from the worsening risk-return trade-off to the beginnings of the benefits of diversification. The third empirical study investigates the influence of the cost of deposits, market power and the business cycle on the bank capital buffer determination. The findings imply that the capital buffer is positively associated with the cost of deposits, bank market power and the business cycle. The findings indicate that the higher the cost of deposits and the greater their market power, banks tend to hold a greater capital buffer. Furthermore, the capital buffer can vary pro-cyclically with the business cycle suggesting that banks can increase their capital buffers by expanding through various lending during economic upturns which will provide opportunities for banks to make use of this excess capital during recessions. Further, the findings suggest that the banking sector can contribute to the performance of the economy if they hold sufficient buffers and retain a healthy flow of credit when the economy is in crisis. This analysis provides some insight into ASEAN banks’ response to Basel III, which indicates that these banks will find it much harder to comply with the new regulations. This study contributes to the literature through providing evidence of the ASEAN banks’ diverse responses in the aftermath of the AFC and pre- and post-GFC with regard to the research issues. In addition, this thesis adds to the limited, but fast growing, literature on bank market power by using an improved version of the Lerner index in the form of a Funding adjusted Lerner index. Regarding the methodology, unlike other studies, this thesis extends the literature by addressing endogeneity by employing the GMM method for estimation. In addition, this thesis is includes a broader set of bank-specific, country-specific and industry-specific determinants together to address the research issues. Apart from the academic contributions, this thesis offers several implications for bankers, shareholders and regulators. The regional focus of the analysis provides useful insights for ASEAN banks for future policy formulation involving bank market power, credit risk, revenue diversification, bank stability, net interest margin, cost of deposits and the business cycle, given the restructured banking system in the region.

Under Basel III, banks are required to build up countercyclical capital buffers during periods of excessive credit growth to cover future credit losses. Based on a review of the credit boom episodes in sixteen Central, Eastern, and Southeastern European countries during 2000s, two measures of excessive credit are calculated: one based on the Hodrick-Prescott filter, as suggested by the Basel Committee for the activation of the countercyclical buffer, and the other based on an estimate of equilibrium credit. While the filtering-based measure signals future credit losses quite well, using the measure based on equilibrium credit improves the forecast of future deleveraging and its impact on GDP.

We investigate the time variability of abnormal returns from socially responsible investing (SRI). Using portfolio regressions and event studies on multiple data sources, including analyst ratings, firm announcements, and realized incidents, we find that highly rated SRI stocks outperform lowly rated SRI stocks during good economic times, for example, periods with high market valuations or aggregate consumption, but underperform during bad times, such as recessions. This variation in abnormal returns of high-SR stocks vis-à-vis low SR stocks is consistent with a wealth-dependent investor preference for SR stocks that leads to an increased (decreased) demand for SRI during good (bad) times.

Risky firms and fragile banks: implications for macroprudential policy

Capital buffer serves to anticipate the risk of unexpected banking systemic risks. Capital buffer is derived from the difference between banks’ capital adequacy ratio (CAR)and the minimum capital adequacy ratio (minimum CAR) regulated by policymakers. This research is made to know what factors affect capital buffer in Indonesia Islamic Commercial banks. These factors include Return On Equity (ROE), Non-Performing Finance (NPF), Financing to Deposit Ratio (FDR), and Gross Domestic Product (GDPG). This study uses secondary data obtained from the official website of OJK, the official website of the Islamic banks, and BPS Agency for a period of 5 years in 2014-2018 on quarterly data. The analysis technique used is Multiple Linear Regression Analysis. The results show that the Return on Equity (ROE), Non-Performing Finance (NPF), Financing to Deposit Ratio (FDR), and Gross Domestic Product (GDPG) affected Capital Buffer in Islamic Commercial Banks in Indonesia simultaneously. While it is partially obtained that the Financing to Deposit Ratio (FDR) variable has a significant and negative effect on the Capital Buffer. Return On Equity (ROE) and Non-Performing Finance (NPF) has insignificant and negative effects on the capital buffer. Gross Domestic Product Growth has an insignificant and positive effect on the capital buffer at Islamic Commercial Banks in Indonesia.