Erscheinung:04.09.2019 | Reference number R 1-AZB 1134-2019/0001 | Topic Macroeconomic supervision, Own funds General Administrative Act governing the rate for the domestic countercyclical capital buffer under section 10d of the KWG

Pursuant to section 10d of the KWG and in accordance with the Recommendation of the German Financial Stability Committee as of 27 May 2019 the rate for the domestic countercyclical capital buffer is set at 0.25 per cent of the total risk exposure amount determined in accordance with Article 92(3) of Regulation (EU) No. 575/2013, effective 1 July 2019.

This translation is furnished for information purposes only. The original German text is binding in all respects.

The Federal Financial Supervisory Authority is enacting the following

General Administrative Act:

1. Effective 1 July 2019, the rate for the domestic countercyclical capital buffer is increased to 0.25 per cent of the total risk exposure amount determined in accordance with Article 92(3) of Regulation (EU) No. 575/2013.

2. With effect from 1 July 2020, the rate specified in paragraph 1 must be used to calculate the institution-specific countercyclical capital buffer.

3. The General Administrative Act is addressed to institutions as defined in section 1 (1b) of the Banking Act (Kreditwesengesetz – KWG) and to groups of institutions, financial holding groups and mixed financial holding groups in which at least one member is an institution that must meet the requirements of section 10d (1) sentence 1 of the KWG at the individual institution level, as well as institutions referred to in Article 22 of Regulation (EU) No. 575/2013. It does not apply to the undertakings referred to in section 2 (9c) and (9e) of the KWG as well as the undertakings referred to in section 2 (9g) and (9h) of the KWG, subject to the conditions set out there.

4. The General Administrative Act is deemed to be announced on the day following its publication.

Grounds:

I.

The Act transposing Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms and aligning supervisory law with Regulation (EU) No. 575/2013 on prudential requirements for credit institutions and investment firms (Act Implementing CRD IV – CRD IV-Umsetzungsgesetz) introduced the requirements set out in section (10d) of the KWG governing the countercyclical buffer with effect from 1 January 2014. This transposed into German law the requirements of Articles 130, 135 to 140 of Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (Text with EEA relevance) (Capital Requirements Directive – CRD).

On 18 June 2014, the European Systemic Risk Board adopted a Recommendation on guidance for setting countercyclical buffer rates (ESRB/2014/1).

In 2015, the Deutsche Bundesbank and the Federal Financial Supervisory Authority (BaFin) published a methodological note on setting the rate for the countercyclical capital buffer in Germany with the title “Analytical framework for the assessment of an appropriate domestic buffer rate” (referred to in the following as the “methodological note”) that takes Recommendation ESRB/2014/1 into account. To set the rate for the domestic countercyclical capital buffer, the methodological note stipulates, in a first step, the calculation of a buffer guide that is based on the deviation in the ratio of domestic lending to GDP (ratio of credit-to-GDP) from the long-term trend and is normally higher than zero if the ratio of credit-to-GDP deviates by more than two percentage points from its long-term trend.

There are different approaches to calculating the buffer guide. The first of these is to calculate the buffer guide using the standardised method. This corresponds to a proposal by the Basel Committee on Banking Supervision (BCBS) on how to calculate the deviation in the ratio of credit-to-GDP from its long-term trend (credit-to-GDP gap, see also the definition in section 2.1.1. (d) of ESRB/2014/1). The buffer guide can also be calculated using the methodology described in greater detail in the methodological note, which differs from the standardised method due to its narrower definition of credit and a modification of the conversion formula for the buffer guide. The national method produces more beneficial results than the standardised method (see page 18 et seq. of the methodological note).

According to the methodological note, the buffer guide is a “rule-based component” that represents an indicator for setting the rate for the domestic countercyclical capital buffer, but that does not lead to any automatic setting of the rate for the domestic countercyclical capital buffer. The rate for the domestic countercyclical capital buffer is set in an overall assessment that, in addition to the buffer guide, takes into account supporting indicators that capture important aspects of financial stability, as well as additional information if appropriate.

Effective 1 January 2016, BaFin set the rate for the domestic countercyclical capital buffer at 0 per cent. In this respect, reference is made to the General Administrative Act on the setting of the rate for the countercyclical capital buffer pursuant to section 10d (3) sentence 2 of the German Banking Act (Kreditwesengesetz – KWG) of 28 December 2015, reference number BA 51-AZB 1130-2015/0009. Since that date, the rate has been assessed once a quarter in accordance with the requirements of section 10d (3) sentence 2 of the KWG. In its assessment, BaFin has been considering deviations in the ratio of credit-to-GDP from its long-term trend and any recommendations by the Financial Stability Committee (section 10d (3) sentence 3 of the KWG).

As at the third quarter, the buffer guide calculated in accordance with section 33 (1) of the Regulation governing the capital adequacy of institutions, groups of institutions, financial holding groups and mixed financial holding groups (Verordnung zur angemessenen Eigenmittelausstattung von Instituten, Institutsgruppen, Finanzholding-Gruppen und gemischten Finanzholding-Gruppen) (Solvency Regulation/Solvabilitätsverordnung – SolvV) and calculated pursuant to the methodological note was 0 per cent. The credit-to-GDP gap on which the buffer guide is based changed as follows since the second quarter of 2018 (amounts shown in percentage points):

	Q2 2018	Q3 2018	Q4 2018	Q1 2019
National credit-to-GDP gap	-2.00	-1.43	-0.85	-0.22
Standardised credit-to-GDP gap	-1.20	-0.98	0.57	n.a.

Based on the most recent figures available for the first quarter of 2019, the credit-to-GDP gap calculated using the national method is thus 0.22 percentage points.¹ After 0.85 percentage points in the fourth quarter of 2018 and –1.43 percentage points in the third quarter of 2018, the credit-to-GDP gap has been moving towards the activation threshold.

Using the standardised method (based on the proposal in the BCBS guidance for calculating the credit-to-GDP gap), the credit-to-GDP gap is 0.57 percentage points for the most recent quarter available (fourth quarter of 2018), following 0.98 percentage points in the third quarter of 2018.

The longer-term trend for the credit-to-GDP gaps using the national and standardised methods is shown in the following graphic:

Credit-to-GDP Gaps

Credit-to-GDP Gaps The graphic shows the credit-to-GDP gap using the national and standardised methods. The activation threshold describes the value above which a positive buffer guide would normally result. BaFin

This graphic shows that, despite the differences in calculating the credit-to-GDP gap using the standardised and national methods when it comes to the details, the changes are similar and the trends generally match in both cases.

On 17 May 2019, the International Monetary Fund (IMF) published the Concluding Statement on its 2019 Article IV Mission. The IMF concludes that there are cyclical systemic risks in Germany and recommends raising the countercyclical capital buffer in order to enhance resilience in the banking system.²

Furthermore, the Financial Stability Committee adopted the following Recommendation at its meeting on 27 May 2019:

„The Federal Financial Supervisory Authority […] is recommended, pursuant to section 10d(3) sentence 2 of the Banking Act (Kreditwesengesetz), to set the rate for the domestic countercyclical capital buffer at 0.25 percent of the total risk exposure amount determined pursuant to Article 92(3) of Regulation (EU) No 575/2013 as of the third quarter of 2019.“

This recommendation is based on an analysis and assessment of the risk situation for the German banking system by the Financial Stability Committee with the conclusion that there are cyclical systemic risks that can impair financial stability in Germany.

The explanatory remarks on the recommendation by the Financial Stability Committee explain the background to the recommendation in detail (the footnotes from the recommendation are added in square brackets to the quoted text below):

„[…]

B. Explanatory remarks

The Committee has concluded from its analysis and assessment of the risk situation for the German banking system that there are cyclical systemic risks which can impair financial stability in Germany. Owing to these cyclical systemic risks, the Committee deems it necessary to strengthen the loss-absorbing capacity of the German banking system. This is intended to avert adverse feedback loops between the financial system and the real economy, should a period of stress arise. This would notably be the case if banks were no longer capable of providing bank lending to the extent required by the real economy. To mitigate the effects of a materialisation of such risks and the associated repercussions for the economy, the Committee recommends, in performance of its statutory mandate pursuant to section 2(2) number 5 of the Financial Stability Act, that the domestic countercyclical capital buffer (hereinafter referred to as the “CCyB”) be increased.

I. Macroeconomic and financial setting in Germany

The German economy is experiencing the longest period of expansion since the country’s reunification.[See Deutsche Bundesbank (2018)] Interest rates have been exceptionally low for a number of years, and asset prices are high. Furthermore, volatility in financial markets is relatively low. Germany’s economy remains on a growth path, despite the fact that it is currently experiencing a weaker spell, and capacity utilisation is at an above-average level. Favourable labour market developments are bolstering household income and consumption. High capacity utilisation and labour market shortages in the euro area support the expectation of consumer prices rising over the medium term and of the interest rate level increasing at a slow pace. However, geopolitical uncertainties have also risen, and trade conflicts have intensified. The United Kingdom’s intention to withdraw from the European Union is another potential setback for the economy as a whole.

II. Risks to financial stability

The functional viability of the financial system is of essential importance for the real economy. Financial stability is defined as a state in which the financial system is able to fulfil its functions at all times. The main functions comprise the allocation of financial resources and risks as well as the settlement of payments. This means that a stable financial system is consistently in a position to absorb both financial and real economic shocks, including in stress situations and periods of structural adjustment. An adequate resilience of the financial system – that is, the ability to cushion even losses from unexpected developments – can prevent contagion and feedback effects between the financial market participants and between the financial system and the real economy. The financial system should neither cause nor amplify a downturn in overall economic activity.

Averting risks to financial stability is the task of macroprudential oversight. Unlike microprudential supervision and regulation, which aim to ensure the stability of individual credit institutions, macroprudential oversight focuses on the stability of the financial system as a whole. Risks to financial stability arise from systemic risks. Systemic risks occur, for instance, when the distress of one or more market participants jeopardises the functioning of the entire system.

The Committee has determined in its macroprudential strategy that the purpose of its measures is to strengthen the resilience of the financial system and, inter alia, to counteract the cyclical build-up of systemic risks.[ See German Financial Stability Committee (2014), pp. 42 ff.] Macroprudential measures in the sense of a preventive policy are therefore aimed, amongst other things, at strengthening the resilience of lenders to unexpected adverse events (“shocks”). Such measures typically address lenders’ shock absorption capacity – that is to say, their capital base. The Committee is expressly not aiming to fine-tune the national economy or lending activity.

1. Threat situation

The Committee has assessed that, in the current economic setting, the build-up of cyclical systemic risks has created a threat to financial stability. If these cyclical systemic risks materialised, there would be the danger that banks might only be able to bear the resulting losses by curbing the flow of funding to the real economy. This can lead to the creation of adverse feedback loops between the financial system and the real economy, because banks in particular would be hit in their function as a credit provider.

The threat situation results from three risk areas: (i) risks relating to the path of the economy which are not comprehensively covered by microprudential credit risk measurement (“economic risk”); (ii) real estate lending risk (“real estate risk”); and (iii) interest rate risk – that is, the risk of interest rates persisting for even longer at the zero lower bound (“low interest rate environment”) or rising sharply (“interest rate risk”). The threat situation is derived in particular from the simultaneous materialisation of the various risks.

(i) Economic risk

The healthy state of the economy has reduced credit risk, as reflected by low risk provisioning by banks and a drop in risk-weighted assets (RWAs) for market risk. This is consistent with the, on average, improvement of balance sheet metrics in the corporate sector. However, analyses by the Bundesbank and the International Monetary Fund up to 2015 and 2016, respectively, signal that increased lending activity was related to allocation risk.[See Deutsche Bundesbank (2018) and International Monetary Fund (2018a).] In the period under review banks increased the supply of credit to comparatively financially weaker enterprises.[ See Deutsche Bundesbank (2018), pp. 73 ff.] In other words, loans were granted more to enterprises whose balance sheet metrics tended to be weaker than those of other enterprises, even though the balance sheet metrics of all enterprises had improved on average.

These weaknesses can be seen in both the capital ratios and the interest coverage ratios of these enterprises. If the economy were to worsen, credit quality levels of these enterprises in particular could deteriorate to such an extent that loan losses would increase. Banks would be forced to step up their risk provisioning, perhaps substantially, at short notice. Scenario analyses prepared on the basis of supervisory reporting data reveal that capital ratios would come under intense pressure if impairment ratios and thus risk provisioning were to rise again or even go beyond the normal magnitude on account of a cyclical downturn.[See Deutsche Bundesbank (2018), p. 79.] Analyses based on stress tests indicate that banks are likely to respond to a scenario of unexpectedly heavy losses from the aforementioned risk areas, at least in part, by deleveraging as a way of stabilising their tier 1 capital ratios.[See Deutsche Bundesbank (2018), p. 80.] Because of the impact this would have on balance sheets, this scenario can be expected to cause banks to curb the supply of credit to an excessive degree, which would have a negative knock-on effect on the real economy.

The scenario described here concerns all banks. At banks using the Credit Risk Standardised Approach to calculate their capital requirements (SA banks), migrations of loans into classes subject to higher risk weights could drive up capital requirements. At banks using the Internal Ratings-Based Approach to calculate their capital requirements (IRB banks), the described effects would tend to be more pronounced due to the higher risk sensitivity of internal models. Measured as an average for the past nine years, IRB risk weights are currently at a low level. They could increase sharply if the economy takes a downturn. That would be problematic from a macroprudential perspective as primarily potential systemically important institutions (PSIs) are using internal models (IRB PSIs). IRB PSIs include banks which apply the IRB approach and are categorised as posing a potential systemic risk pursuant to section 20(1) sentence 3 of the Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz). These notably include other systemically important institutions (O-SIIs) pursuant to section 10g of the Banking Act as well as those institutions for which simplified requirements cannot be applied to their recovery plans pursuant to the criteria set out under section 19(2) of the Recovery and Resolution Act. Both the categorisation as O-SIIs and the granting of simplified requirements for recovery plans are based on a methodology shared by BaFin and the Bundesbank. This methodology is based on guidelines issued by the European Banking Authority (EBA) and a Commission Delegated Regulation. The group of IRB PSIs is of particular importance for the German banking system, since these institutions are responsible for a large share of domestic lending to the private non-financial sector (around 40%) and account for the bulk of the German banking system’s aggregate total assets (roughly 54%).

Capital reserves as a proportion of total assets, including the capital buffer and the surplus capital held over and above that, are low at IRB PSIs compared with small and medium-sized banks. The stress test also shows that banks whose tier 1 capital ratios are closer to the regulatory minimum reduce their assets to an above-average extent.[See Deutsche Bundesbank (2018), p. 80.] Therefore, IRB PSIs are more at risk of being unable to cushion losses from unexpected macroeconomic developments using their existing capital reserves. This means that there is a strong risk of deleveraging (i.e. a collective shortening of the balance sheet) in this key group of banks for the financial system and therefore the risk of a procyclical amplification of a potential economic downturn.

(ii) Real estate risk

The German real estate market has been undergoing a remarkable upswing since 2010. In 2018, as in 2017, the overvaluations in towns and cities were between 15% and 30%.[See Deutsche Bundesbank (2019), p. 55.] Other indicators for assessing real estate prices, such as the ratio of purchase prices to annual rents, for example, support the view that valuation levels in towns and cities have remained high.[See Deutsche Bundesbank (2018), p. 46 and Deutsche Bundesbank (2019), pp. 53-55.] Due to the sharp rise in real estate prices over the past decade (during the 2010 to 2018 period, real estate prices in Germany were up by 59% overall and in Germany’s seven largest cities by around 98%)[Bundesbank calculations based on data provided by bulwiengesa AG.] and estimated price exaggerations in residential real estate markets, the probability of a − considerable − price correction is rising. An unexpectedly sharp decline in real estate prices, especially in conjunction with an economic slump, can lead to turmoil in the real estate markets. In such a scenario, if household incomes deteriorate significantly and real estate prices drop at the same time, this can lead to rising defaults on residential real estate loans and an increase in losses given default when liquidating real estate collateral.

Turmoil in the real estate markets would hit the overall German banking system: In the fourth quarter of 2018, over 50% of lending to domestic households and enterprises by the savings banks and credit cooperatives was accounted for by housing loans to households. For commercial banks, this figure is just over 37%. The results of a residential real estate stress test show that, over a three-year stress scenario in which, amongst other things, residential real estate prices drop by a total of 30%, banks’ estimated expected losses would rise considerably.[ See Deutsche Bundesbank (2018), pp. 61-62] These rising losses would affect both new and older loan vintages. The risk of losses in the loan portfolio is therefore not eliminated by the significant appreciation of the residential real estate serving as loan collateral, caused by rising prices in the past.

Unlike in the case of portfolio risk, for which there is sufficient evidence, data gaps make it difficult to comprehensively analyse risks from new housing loans. Currently available indicators do not show any risks to financial stability that are so substantially heightened as to signal a need for macroprudential action to be taken at present.

In addition, should funding conditions deteriorate suddenly (see section B.II.1.iii regarding interest rate risk on page 6), the commercial real estate market could also increasingly come under pressure, as it is characterised by shorter-term and more floating rate financing. To make matters more difficult, it is possible that banks, in the current environment of dynamically rising real estate prices, might overestimate the value of real estate accepted as collateral and thus underestimate the risk of their credit exposure.

(iii) Interest rate risk

Interest rate risk likewise affects all banks. Interest income accounts for an important share of total income for small and medium-sized banks, in particular. Persistently low interest rates weigh on net interest income and thus, over the longer term, on banks’ solvency as well. Banks’ weak earnings give them an incentive, because of low interest margins, to increase their risk-taking and expand their lending in order to generate income. An abrupt rise in interest rates would, in addition, make funding more expensive over the short to medium term and erode the value of fixed-rate assets, in particular. In the event of an increase in interest rates, credit risk could also rise if the interest burden on borrowers goes up. The resilience of the banking system to interest rate risk is therefore of particular importance.

2. Insufficient shock absorption capacity

The Committee is concerned about whether the banking system is able to cushion potential unexpected shocks that might arise if the aforementioned cyclical systemic risks materialise, without curbing the function it performs for the real economy. It refers here to analyses according to which, if cyclical systemic risks materialise, the banking system at least in part could be forced to shrink its balance sheet. Stress test-based analyses show that banks under stress would deleverage their total assets considerably in order to maintain sufficient capital to comply with supervisory or market capital requirements. Given the current level of German banks’ capital, there is believed to be a sufficient probability of considerable deleveraging if the aforementioned risks do materialise. This is particularly true for IRB PSIs, which have only little excess capital compared with other banks. One of the potential consequences would be a significantly constrained supply of credit to the real economy. Under those circumstances, the banking system could no longer sufficiently play its role for the real economy. This is why resilience and the associated loss absorption capacity of the banking system need to be strengthened as a preventative measure.

3. Impairment of financial stability

Collectively, the three types of risk described above, which are in some instances interdependent, result in a scenario of a cyclical systemic risk. Each type of risk individually, as well as a combination of all three, can lead to undesirable adjustment reactions if banks’ loss absorption capacity is insufficient. There is also the possibility of herd behaviour in the banking system in response to the materialisation of the risk scenario..

The possibility that, in such situations, the ability to increase capital by retaining profits or borrowing on the market is constrained cannot be ruled out; in that case, the only other option would be to shrink the balance sheet or reduce risk-weighted assets. If banks are not able to cushion losses from macroeconomic shocks through capital held in excess of regulatory requirements, they are forced to take balance sheet measures (capital increase, asset deleveraging) to stabilise their capital ratios. Stabilising capital ratios through collective balance sheet contraction, such as by reducing lending, would amplify an economic downturn (procyclicality) and adversely affect the real economy. This subsequently creates considerable potential for economic losses should the aforementioned risk scenarios materialise.

The lengthy upswing has created the potential for a macroeconomic setback − in the form of, for instance, simultaneous and suddenly increasing credit defaults caused by falling GDP, increased risk of losses caused by falling real estate prices, or rising risk weights. By those standards, the German banking system’s ability to absorb losses is low. This is where the Committee sees a threat to financial stability. Implementing this recommendation is intended to enhance banks’ resilience to the effects of the materialisation of cyclical systemic risks. It must be noted that taking macroprudential measures to strengthen resilience is exclusively preventive.

When selecting and calibrating macroprudential instruments to avert the impairment to financial stability explained here, the remaining uncertainties regarding both the probability of the above described risks materialising and the size of potential expected losses are taken into account.

III. The countercyclical capital buffer as a measure to strengthen resilience to financial stability risks

The Committee thinks that setting a rate of 0.25 percent for the CCyB pursuant to section 10d of the Banking Act as of the third quarter of 2019 is a suitable and necessary measure to avert the aforementioned threat to financial stability. Although banks’ capital adequacy and the associated loss absorbing capacity are consistent with the currently favourable economic environment (microprudential dimension). However, they do not sufficiently cover unexpected, adverse systemic developments (macroprudential dimension). Setting a positive rate for the CCyB will strengthen the banking system’s resilience and thus reduce the likelihood of the banking system responding procyclical in an economic downturn scenario. In the Committee’s opinion, no other less severe but equally effective means of averting risks to financial stability are available. Banks have 12 months to build up this buffer. The appropriateness of the CCyB rate will also be subject to quarterly review during this phase-in period – particularly in terms of GDP and credit growth – and any adjustments deemed necessary will be made.

1. Suitability of the CCyB

The cyclical systemic risk situation and the resultant threats to financial stability engender the need for a macroprudential buffer to enhance the resilience of the banking system. The CCyB was created with a view to enhancing resilience to cyclical systemic risks. It is intended to enhance banks’ capacity to absorb losses by building up additional capital reserves during the phase of a rise in cyclical systemic risk, which in the run-up to past financial crises has often been reflected in excessive growth in credit to the private non-financial sector. If risks materialise in a downturn, the buffer can be immediately reduced or tapped in order to cover losses. This is ultimately designed to stabilise lending since, by tapping the CCyB, banks would not be forced to reduce their assets in order to cover losses.[ See Basel Committee on Banking Supervision (2010) and European Systemic Risk Board (2014).] The CCyB is, by that token, economically suited, and can be used in a targeted manner, for restricting the procyclicality of the financial system.

Existence of the preconditions for the CCyB

From the Committee’s point of view, the preconditions for activating the CCyB are in place. Even though the credit-to-GDP gap currently does not indicate a positive buffer guide (reference value derived from the credit-to-GDP gap) for setting a CCyB rate, further indicators point to the need for activation. There are also the aforementioned cyclical systemic risks.

Building on the legal basis, BaFin and the Bundesbank have defined a methodological framework for the application of the CCyB and particularly for deciding on the appropriate CCyB calibration. When setting the CCyB rate, two components are taken into account according to the methodological framework.[ See Deutsche Bundesbank (2015), hereinafter “methodological note”.] The starting point is the rules-based component based on the deviation of the credit-to-GDP ratio from its long-run trend (credit-to-GDP gap). From this, a reference value for the CCyB rate is derived (buffer guide). If the credit-to-GDP gap exceeds two percentage points, the build-up of a buffer is indicated. This guide is not a strict rule. As part of the discretionary component, additional quantitative and qualitative indicators of cyclical systemic risk are taken into account. After looking at all the information from the rules-based and discretionary components, the CCyB rate is then set.

(i) Rules-based component

The key indicator in the rules-based component is the credit-to-GDP gap as calculated using the national method. In the fourth quarter of 2018 it stood at -0.84 percentage point. For 20 quarters now, the gap has been moving towards positive territory. The credit-to-GDP gap calculated using the national method incorporates credit granted by domestic monetary financial institutions (MFIs) to the domestic private non-financial sector. Alongside the national method, the credit-to-GDP gap according to the Basel method is also used to ensure comparability at the international level. This method uses a broader definition of credit which also includes credit granted by foreign lenders and credit granted by non-banks. The credit-to-GDP gap according to the Basel method was -0.42 percentage point in the third quarter of 2018. The buffer guides based on the national and Basel methods thus both came to 0%.

In addition to the current figure, the Committee also looks at the dynamics of the development of the credit-to-GDP gap. Only by building up buffers at an early stage can it be ensured that capital buffers are actually available in a crisis or a cyclical downturn. The credit-to-GDP gaps calculated using both the national and Basel methods have been moving towards positive territory over the past few quarters (Figure 1 in the annex on the national credit-to-GDP gap). Based on forecasts, the Committee is of the view that, if this development continues, the credit-to-GDP gap is likely to be in territory that signals an increase in the buffer. Continuation of this dynamic is suggested by the fact that the components of the credit-to-GDP gap (credit, GDP, trend) are slow-moving and statistical features in the calculation of the trend encourage persistent developments. The rate of change in the credit-to-GDP gap is thus indicating that the gap will lie above the 2 percentage point threshold in future.[ If the quarterly rates of credit growth were to increase in line with average long-term credit growth (fourth quarter of 2018: 1.44% since 1968) and nominal GDP grow in line with the long-term forecast of the International Monetary Fund, the 2 percentage point threshold would be exceeded in the second quarter of 2020 according to an analysis of the credit-to-GDP gap. Given sustained credit growth at the growth rate seen in the third quarter of 2018 (1.01%), the credit-to-GDP gap would reach this level at the start of 2022.] At present, the credit-to-GDP gap is already higher than the long-term average.

(ii) Discretionary component

Article 136(3) letter (c) of the Capital Requirements Directive (CRD IV) provides for other variables that the designated authority considers relevant for identifying cyclical systemic risks to be taken into account when setting the CCyB.

Due, in particular, to the uncertainty surrounding the predictive power of the credit-to-GDP gap, the additional indicators play an important role in the decision on the appropriate level of the CCyB.[ See Deutsche Bundesbank (2015).] The indicators specified in the methodological note are not definitive, however. In line with the legal provisions, the methodological note provides for the option of reviewing and expanding the analytical framework.[The Basel Committee on Banking Supervision (2010) and the European Systemic Risk Board (2014) also note that the credit-to-GDP ratio is a purely statistical measure and information derived from it can be misleading. As a result, automatically implementing the buffer guide based on the gap could, in the event of misleading signals, lead either to no buffer activation while risk builds up simultaneously (type 1 error) or to buffer activation with no simultaneous risk build-up (type 2 error).] Besides the set of indicators, further information that signals a build-up of cyclical systemic risks can thus be used, as limited experience in the application of the CCyB argues against a rigid analytical framework.

Aside from growth in aggregate lending, other factors that are relevant to the build-up of systemic risks are the structure and concentration of lending. In the fourth quarter of 2018, real growth in MFI loans to non-financial corporations came to 5.14% compared with the same quarter of the previous year, and it has been above the average since 1991 (1.97%) for ten quarters. In addition to the above average growth in loans to non-financial corporations, the risk weights for loans to enterprises at banks using internal models to calculate their capital requirements have also dropped in median terms from 57% to just under 37% over the past nine years.[This change does not stem solely from cyclical developments.] Because large banks, in particular, use internal models, a significant share of aggregate lending to the private non-financial sector is affected by the decrease in the risk weights. Hence, only a correspondingly smaller amount of capital has to be held against lending exposures.

The residential real estate indicators are pointing to a persistent build-up of risks, primarily in relation to price developments. If the long-lasting high prices diverge from the fundamentally justified prices, the valuation of collateral could be unsustainable. At present, growth in residential real estate prices compared with the same quarter a year earlier has been higher than the average since 1991 (2.8%) for 18 quarters. The growth rates in the past four quarters were all over 5%. At the same time, real growth in housing loans,[See Deutsche Bundesbank (2015), p. 46. Growth (p.a.) in loans to households and enterprises for house purchase. Creditors are domestic monetary financial institutions. Credit growth adjusted using the consumer price index. Calculation of average growth rates based on the geometric mean.] at 3.01% in the fourth quarter of 2018, is above the long-term average since the first quarter of 1991 (2.29%).[The nominal growth rate of loans to households for house purchase, i.e. excluding enterprises, was 4.46% at the end of the third quarter of 2018.]

According to the results of the quarterly euro area bank lending survey (BLS) conducted by the Eurosystem, credit standards in Germany have eased for several consecutive quarters; at the current end, they have tightened only marginally (BLS results for the first quarter of 2019, results of analyses for German CCyB in the second quarter of 2019). Because in Germany standardised data on credit standards such as the loan-to-value ratio (LTV) of housing loans or households’ debt-service-to-income ratio (DSTI) are not reported, the estimation of lending standards is subject to a degree of uncertainty. Nonetheless, among the set of indicators in the CCyB, the residential real estate indicators are pointing to a build-up of risk. Given that housing loans are a key pillar of banking business in Germany, we need to keep a particularly close eye on this area.[See Deutsche Bundesbank (2015), p. 22 and the literature cited there.]

Overall, developments in the credit-to-GDP gap (aggregate lending), growth rates for MFI loans to non-financial corporations involving low risk weightings and low risk provisioning (distribution of lending) and price movements for residential real estate (potential overvaluation of credit collateral) point to a build-up of cyclical systemic risks, reflecting the risk areas. From the point of view of the Committee, a CCyB rate that deviates from the current buffer guide is therefore justified.

Right time to set the rate

It is appropriate to set a positive rate for the CCyB for the first time given the economic environment. In the current economic situation, which remains upbeat, it would thus be consistent with the preventive character of macroprudential policy in general and of the CCyB in particular. The aim should be to use a favourable macroeconomic setting to enable the banking system to conserve and/or accumulate sufficient equity capital in the form of buffers to render it suitably resilient to risks, should they materialise.[ See recital 80 of CRD IV.] Nor do current data, for example on loans to enterprises or growth in residential real estate prices, indicate an end to the build-up of risk. Recently, the Financial Stability Board stated that the (still) positive economic environment should be used to build up capital buffers, especially in the advanced economies.[ Source: http://www.fsb.org/2018/10/fsb-reviews-financial-vulnerabilities-and-deliverables-for-g20-summit/] The International Monetary Fund, too, recommends that countries consider making more active use of the CCyB in light of the deteriorating economic activity.[ See International Monetary Fund (2018b), p. 31. Currently (first quarter 2019), 12 out of the 31 countries in the European Economic Area have introduced or announced the introduction of a positive CCyB rate.]

Appropriate calibration of the CCyB

Given the remaining uncertainty as to the likelihood of the threat situation described here materialising and the severity of the associated economic repercussions, the Committee considers it appropriate to raise the CCyB for the first time by 0.25 percentage point as of the third quarter of 2019. The implementation deadline is in 12 months’ time, meaning that credit institutions need to have built up the buffer in full by no later than the third quarter of 2020.

In the Committee’s opinion, the CCyB will bolster the German banking system’s resilience to an unexpected, strong economic downturn. It will reduce the risks arising from procyclicality whilst ensuring that the economic cost of accumulating the buffer remains low. An analysis of capital requirements shows that German banks can achieve a CCyB rate of 0.25% primarily by drawing on existing excess capital. As a result, neither a short-term balance sheet contraction nor any resulting distortions seem likely on aggregate. The 12-month implementation deadline will allow the few banks with capital needs sufficient time to decide how best to accumulate capital. The banking system will become more resilient in the sense that the CCyB will preserve existing excess capital in the short term and give banks an incentive to build up additional capital in the medium term.[Even if the buffer were to be met entirely using excess capital, the resilience of the banking system would be improved because capital distribution constraints would ensure that capital was preserved for crises. Banks will have an incentive to rebuild their original excess capital in order to increase their flexibility in terms of business policy.]

The increase in the CCyB will be of significant benefit to all, at a reasonable cost to the banking system, since the banking sector will be better equipped to face the impact of cyclical systemic risks. This will reduce the above described negative repercussions for all, for example due to the anticipated deleveraging. Estimates show that, even if banks were to create their buffers entirely from new equity capital, this would only have a small impact on funding costs and lending rates.

The CCyB is being activated for the first time at a rate of 0.25 percentage point on the back of a baseline scenario surrounded by the abovementioned uncertainties. Its appropriateness in each case is to be reviewed taking into account future developments as part of the legally envisaged quarterly evaluation of the CCyB rate. The rules-based and discretionary components listed above form part of this evaluation. One of the key characteristics of the CCyB is that it is applied counter to the credit cycle and can be lowered in periods of stress.

2. Necessity of the CCyB

It is necessary to set a positive rate for the CCyB. In the Committee’s opinion, no other less severe but equally effective means of averting risks to financial stability are available. This assessment reflects the fact that macroprudential buffers such as the CCyB perform a function fundamentally different to that of microprudential minimum capital requirements. While minimum capital requirements need to be met at all times and undershooting these directly results in measures ranging from supervisory action to the withdrawal of banking licences, macroprudential buffers may be undershot under certain circumstances (“breathing buffers”). Unlike microprudential minimum capital requirements, these can therefore be used by banks to absorb losses on a going-concern basis. The possibility of absorbing losses in this way provides banks with immediate financial leeway, thereby mitigating any negative effects stemming from the banking system in a cyclical downturn.

Given the currently low level of loss-absorbing capacity, the overall risk situation implies cyclical systemic risks that entail the threat of a collective shortening of the balance sheet in the event of a crisis. Microprudential requirements not only lack the breathing and loss-absorbing function that is inherent to the macroprudential buffers. On top of this, it would not be possible to address systemic risk by increasing microprudential minimum requirements. An increase in minimum requirements on the basis of Articles 124 and 164 of the Capital Requirements Regulation (CRR) (Pillar 1, risk weight adjustment in the case of mortgage loans) or in the context of Pillar 2 requirements (P2R) raises the cyclical risk in the short term because, upon the materialisation of cyclical systemic risks, capital held as part of minimum requirements cannot be utilised to a sufficient extent; rather, it is intended to be used to cover microprudential losses. Compared with capital buffers, adjusting sectoral risk weights also creates an incentive to shift lending business in a manner that is unintended from a supervisory perspective. Finally, a clear delineation of microprudential and macroprudential requirements makes it possible to define the way each works with respect to evaluation and the point at which the measure is activated or deactivated. Furthermore, the ongoing review of permission to use internal models pursuant to Article 101 CRD IV revealed that, from a microprudential perspective, the data used for the IRB approach are representative and appropriate. However, in macroprudential terms, the data available to banks do not tend to cover a complete financial cycle and, given that Germany is experiencing the longest period of expansion since reunification, they are also less well suited to forecasting a macroeconomic shock.

It would also be inexpedient to capture cyclical systemic risks by means of an institution-specific Pillar 2 add-on (Pillar 2 guidance: P2G) that could be geared towards increasing the loss-absorbing capacity of institutions with a similar risk profile. The identified risk harbours an additional financial stability component that cannot be captured by means of an exclusively institution-specific measure such as the Pillar 2 buffer. As the cyclical systemic risk to be addressed is macroprudential in nature, the notion that it is captured in the P2G framework can be ruled out. Measures pursuant to section 10(3) of the Banking Act that put in place increased minimum liquidity requirements at the individual institution level are likewise unsuitable, because the systemic risk is not attributable to a collective liquidity problem.

The buffer for O-SIIs pursuant to section 10g of the Banking Act is ill suited to addressing the identified risks due to how it works. These risks have their foundation not just in the systemic importance of the relevant institutions in line with their O-SII designation but also in the cyclical decrease in the German banking system’s risk provisioning. Activation of the systemic risk buffer pursuant to section 10e of the Banking Act requires the existence of a long-term, structural macroprudential risk. The cyclical property of the identified risk therefore precludes the application of this measure. The macroprudential increase in the capital conservation buffer on the basis of section 48t of the Banking Act is specifically and generally suited to addressing the identified risk. This add-on works in much the same way as the countercyclical capital buffer, although it has a higher capital impact because the buffer is imposed on all exposures rather than just domestic exposures in the case of the CCyB. At the same time, a variation on the capital conservation buffer could only be applied if the CCyB were, for its part, not suited to addressing the identified risk. This is not the case here.

Borrower-based instruments (cap on the loan-to-value ratio and (minimum) amortisation requirement, section 48u of the Banking Act) concern all new loans for the construction or purchase of residential real estate in Germany. They are not suited to addressing the identified overall risk as existing risks in the loan portfolio cannot be addressed. The available indicators likewise show no increased build-up of risks to financial stability arising from new residential real estate loans that would justify the activation of borrower-based instruments pursuant to section 48u of the Banking Act. Furthermore, residential real estate loans represent only part of the identified overall risk.“

BaFin concurs with and endorses the explanatory remarks on the recommendation.

More recent data on changes in the credit-to-GDP gaps and the supporting indicators than the data referred to in the explanatory remarks on the recommendation by the Financial Stability Committee is available to BaFin. The latest figures are published on BaFin’s website.

BaFin assessed the Financial Stability Committee’s explanatory remarks on cyclical systemic risk for plausibility and up-to-dateness, and established that they are accurate overall. BaFin reviewed and scrutinised the individual aspects in depth and considered their accuracy and the correct integration of the arguments.

In addition, based on the most recent data provided by the Deutsche Bundesbank on the countercyclical capital buffer, BaFin assessed the further validity of the Financial Stability Committee’s risk assessment dated 27 May 2019. BaFin considers the risk assessment to still be valid.

Additionally, BaFin analysed the potential impact of the phase-in of the countercyclical capital buffer on the institutions’ capital, based on the COREP reports as at 31 December 2018. In the overall assessment, a German countercyclical capital buffer will result in an additional capital requirement of EUR 5.3 billion for the German banking sector. The institution-specific charge varies between 0.02 percentage points and 0.25 percentage points of the overall capital requirements. Overall, the banking sector can well handle this measure.

In connection with the planned General Administrative Act, BaFin conducted a consultation procedure from 11 June 2019 to 25 June 2019 to give the institutions concerned an opportunity to comment on material facts driving the decision. The consultation was published on BaFin’s website on 11 June 2019.

BaFin received comment letters in response to the consultation.

The comment letters resulted in particular in the following arguments:

It was claimed that the economic situation was less favourable than described by the Financial Stability Committee, and that the activation of the countercyclical capital buffer would therefore come too late. In addition, systemic risks had not accumulated to the extent portrayed by the Financial Stability Committee. And the resilience of the banking system was better than implied by the Financial Stability Committee.

In terms of the details, there was criticism that the economic situation is more advanced than assumed by the Financial Stability Committee, and that the phase-in of a countercyclical capital buffer would therefore potentially have a procyclical effect. It was also claimed that the target equity ratio (Pillar 2 guidance – P2G) was already positively impacting financial stability because it was applied to all institutions. There was a contention that it was not possible to guarantee any actual “cyclical” breathing in the capital requirements by means of the countercyclical capital buffer because it could not reduce capital requirements in a stress situation. Additionally, BaFin should have waited for the results of a survey on lending standards conducted by BaFin and the Deutsche Bundesbank before raising the rate for the domestic countercyclical capital buffer. Nor were there any interest rate risks that would justify an increase in the rate for the domestic countercyclical capital buffer. The statements concerning shock absorption capacity were purely hypothetical and were not substantiated. Finally, it was claimed that the rules-based component of the rate for the domestic countercyclical capital buffer – the credit-to-GDP gap – did not indicate any increase in the rate for the domestic countercyclical capital buffer.

II.

Re number 1:

The criteria for increasing the rate for the domestic countercyclical capital buffer to 0.25 per cent of the total risk exposure amount determined in accordance with Article 92(3) of Regulation (EU) No. 575/2013 are satisfied.

1. A condition for increasing the rate for the domestic countercyclical capital buffer under section 10d (3) sentence 2 of the KWG is the presence of cyclical systemic risk. This does not result explicitly from the national rules, but from the interpretation of the rules in the KWG and the SolvV.

Setting the rate for the domestic countercyclical capital buffer is governed by section 10d (3) sentence 2 of the KWG and section 33 (1) of the SolvV. Under these provisions, BaFin must consider the deviation in the ratio of domestic lending to the long-term trend as well as any recommendations by the Financial Stability Committee when setting the rate for the domestic countercyclical capital buffer. In addition, under section 7d of the KWG and section 33 (2) of the SolvV, BaFin must consider recommendations made by the European Systemic Risk Board. The national rules do not explicitly contain any additional requirements for setting the rate for the domestic countercyclical capital buffer.

The interpretation of national law, taking the requirements of European law into consideration, reveals the “cyclical systemic risk” criterion. The national rules governing the countercyclical capital buffer implement the requirements of Articles 130, 135 to 140 of the CRD, which are based in turn on the requirements set out in the rules issued by the Basel Committee of the Bank for International Settlements (“Basel III”).³ The background to the requirements is the assumption that excessive credit growth may cause system-wide risks. If the phase of excessive credit growth is followed by a downturn, the banking sector could experience substantial losses that could destabilise the banking sector. The aim is to counter this risk by requiring banks to build up a countercyclical capital buffer that they can release during times of crisis.⁴

Article 136 of the CRD contains more detailed requirements governing the setting of the rate for the domestic countercyclical capital buffer and is therefore significant for answering the question, which set of the criteria must apply when setting the rate for the domestic countercyclical capital buffer. Article 136(3) (a) to (c) of the CRD sets out that three elements must be taken into account when setting the rate for the countercyclical capital buffer:

the buffer guide calculated in accordance with the requirements of Article 136(2) of the CRD (the calculation requirements were transposed into national law in section 10d (3) of the KWG and section 33 (1) of the SolvV in conjunction with sections 10d (5), 10 (1) sentence 1 no. 5 a) of the KWG),
any current guidance by the ESRB in accordance with Article 135(1) (a), (c) and (d) of CRD IV and any recommendations issued by the ESRB on the setting of a buffer rate (the requirement to take into account the ESRB recommendations was transposed into national law in section 7d of the KWG in conjunction with section 33 (1) sentence 4 no. 2 and subsection (2) of the SolvV).
other variables that the designated authority considers relevant for addressing cyclical systemic risk.

The wording “other” variables used in Article 136(3)(c) of the CRD shows that the European lawmakers view the buffer guide as the subset of the main variables for addressing cyclical systemic risk. “Cyclical systemic risk” is hence the high-level concept. Taking into account the requirements of European law and the historical origins, the national rules must also be interpreted in such a way that cyclical systemic risk is also decisive for setting the rate for the domestic countercyclical capital buffer.

2. Such a cyclical systemic risk is present.

a. The term “cyclical systemic risk” is not expressly defined in law, but based on the above it means the risk of disruption in the financial system which has the potential for serious negative consequences for the financial system and the real economy and which is based on a cyclical component (e.g. economic downturn).

Article 3(1) no. 10 of the CRD defines the term “systemic risk” as “a risk of disruption in the financial system with the potential to have serious negative consequences for the financial system and the real economy”.

In addition, this must bear a cyclical reference, which is not defined in any greater detail in the CRD. Interpreting the concept does reveal, however, that a systemic risk is a cyclical systemic risk if the risks can materialise due to a cyclical component, for example an economic downturn. That is because the countercyclical capital buffer serves to accumulate, during periods of economic growth, a sufficient capital base to absorb losses in stressed periods.⁵

Excessive credit growth is not an automatic condition for the presence of cyclical systemic risk. It is certainly the case that the countercyclical capital buffer is supposed to properly reflect the risk to the banking sector of excessive credit growth.⁶ It also happens that cyclical systemic risks accumulate in particular in phases of excessive credit growth because an economic downturn can lead to large losses in the banking sector in these cases and spark a vicious circle.⁷ Based on past experience, the existence of excessive credit growth is therefore a good indicator of cyclical systemic risk. However, because this indicator underpins the calculation of the buffer guide, and other factors that are significant in addressing cyclical systemic risk are also supposed to be taken into account, it is not solely decisive.

b. Cyclical systemic risk is determined on the basis of the Deutsche Bundesbank and BaFin methodological note described under I.

The decision on setting the rate for the domestic countercyclical capital buffer is thus based on the analysis of a range of indicators. The primary indicator is the development of the credit-to-GDP gap, i.e. the deviation in the ratio of lending to gross domestic product from its long-term trend. A series of additional supporting indicators is also used to evaluate the cyclical systemic risk. Finally, other information may be taken into account, such as quantitative and qualitative market and banking supervisory information, as well as stress test results. Ultimately, the rate for the domestic countercyclical capital buffer is set on the basis of a consideration of the overall picture.

aa) Viewed in isolation, the deviations in the ratio of domestic lending to the long-term trend to be considered under section 10d (3) sentence 3 of the KWG do not sufficiently indicate the presence of cyclical systemic risk that would warrant an increase in the rate for the domestic countercyclical capital buffer.

As described above, the credit-to-GDP gap has been narrowing continuously for some time. While it was still –2.00 percentage points in the second quarter of 2018, it rose to –0.22 by the first quarter of 2019. It is possible for the credit-to-GDP gap to indicate cyclical systemic risk in principle (inverse conclusion in Article 136 (3)(c) of the CRD, see above). In the first instance, however, the credit-to-GDP gap only forms the basis for calculating a buffer guide in accordance with the requirements of section 10d of the KWG, section 33 of the SolvV and Recommendation ESRB/2014/1, which were implemented using the method described in the methodological note. Based on the calculation methodologies described in detail in the methodological note, a minimum credit-to-GDP gap of 2.00 percentage points is required to result in a positive buffer guide. Based on the current figure for the credit-to-GDP gap, the buffer guide is currently 0 per cent of the total risk exposure amount determined in accordance with Article 92(3) of Regulation (EU) No. 575/2013. It therefore does not in itself serve as an indicator for increasing the rate for the domestic countercyclical capital buffer.

bb) The further variables to be considered according to the methodological note and Recommendation C.2 of ESRB/2014/1, however, suggest the presence of cyclical systemic risk.

In addition to the deviations in the ratio of domestic lending to the long-term trend, certain other variables are monitored that are referred to as supporting indicators in the methodological note and listed in detail on page 12 of the methodological note. Changes in the indicators are evaluated each quarter. The list can be accessed on BaFin’s website as described above.

An analysis of these indicators reveals that the increase in residential real estate prices has declined most recently to 4.58 per cent in the fourth quarter of 2018 compared with 5.12 per cent in the third quarter of 2018, but for 19 quarters, after all, the growth rate has been higher than the long-term average since 1991 of 2.87 per cent.

Additionally, the rate of growth in housing loans rose from 3.17 per cent in the fourth quarter of 2018 to currently 3.51 per cent in the first quarter of 2019. Growth in housing loans is therefore at its highest level since 2001.

In the first quarter of 2019, real growth in loans to non-financial corporations was 4.68 per cent and therefore lower than in the preceding quarter (5.14 per cent), but for 11 quarters has remained above the long-term average since 1991 of 1.99 per cent.

A large number of banking crises had their roots in wrong-headed developments in the real estate market, for example the subprime crisis. Rising real estate prices are a good early warning indicator of future banking crises.⁸ Paired with high growth in housing loans by historical standards, rising real estate prices increase the probability of future price adjustments. If real estate prices collapse and households experience losses in income due to an economic downturn, this can lead to growing loan defaults and higher loss given default ratios at the banks.

High growth in loans to non-financial corporations by historical standards may indicate excessive growth or undesirable developments in this area. In an economic downturn with growing default rates for corporate loans, this would lead to rising losses at the banks.

cc) In addition, the overall analysis contained in the explanatory remarks on the recommendation by the Financial Stability Committee, which takes further variables into account, verifies the presence of cyclical systemic risk. BaFin concurs with this overall analysis.

The recommendation by the Financial Stability Committee dated 27 May 2019 does not itself constitute either a main variable for addressing cyclical systemic risk, nor does it lead to an automatic increase in the rate for the domestic countercyclical capital buffer. However, under section 10d (3) sentence 3 of the KWG, the recommendation must be taken into consideration when setting the rate for the domestic countercyclical capital buffer.

BaFin re-examined the recommendation and the explanatory remarks and also evaluated them taking account of data that became available after the adoption of the recommendation by the Financial Stability Committee on 27 May 2019. For the details, please refer to the remarks in the Grounds under I. of this General Administrative Act.

BaFin therefore concurs in full with and endorses the substance of point B.II. of the explanatory remarks on the recommendation by the Financial Stability Committee. BaFin also shares the view that the overall analysis of all available variables indicates that cyclical systemic risk is currently present:

An analysis in isolation of changes in the credit-to-GDP gap already suggests that there is a build-up of cyclical systemic risk even though the credit-to-GDP gap has not yet currently reached the threshold at which, based on the legal requirements, a positive buffer guide indicates an increase in the rate for the domestic countercyclical capital buffer. The credit-to-GDP gaps using the national and standardised methods move dynamically in the direction of the threshold of two percentage points. Please refer to the description under I. for details. A positive buffer guide generally results above a threshold of two percentage points.

The following applies to the national method: assuming that credit growth corresponds to the current quarterly growth rate (1.14 per cent) and nominal GDP develops in accordance with the forecast by the International Monetary Fund ⁹ , this would result in a positive buffer guide in the third quarter of 2020, calculated according to the national method. If credit growth develops in line with average long-term credit growth (1.44 per cent – the average since 1968), a positive buffer guide would be indicated in the second quarter of 2020.

Using the standardised method, a positive buffer guide would actually already result in the next quarter (fourth quarter of 2019) if the standardised method assumes current quarterly credit growth (1.74 per cent) or average long-term credit growth (1.40 per cent – the average since 1968) and nominal GDP growth according to the forecast by the International Monetary Fund. The differences in credit growth compared with the national method are due in particular to the fact that a broad credit aggregate is used in the standardised method to measure the debt of the domestic private non-financial sector. In addition, the most recent credit aggregate for the standardised method is available for the fourth quarter of 2018,whereas the credit aggregate for the national method is already available for the first quarter of 2019.¹⁰

To the extent that the consultation resulted in criticism that the current calculations for the credit-to-GDP gap would not lead to a positive buffer guide, it should be noted that this does not mean that there can be no increase in the rate for the domestic countercyclical capital buffer. Rather – as described above – the decision on setting the rate for the countercyclical capital buffer follows the principle of “guided discretion” (as recommended by the European Systemic Risk Board, Recommendation ESRB 2014/1). In addition to the development of the credit-to-GDP gap, both further supporting indicators and other information currently considered to be relevant are taken into account in the decision. This means that the decision on the setting of the rate for the domestic countercyclical capital buffer is specifically not based merely on the rules-based component. Countercyclical capital buffers are also being increased in a number of other countries in the European Union without this being indicated by the rules-based component.

In addition, other aspects addressed in the recommendation by the Financial Stability Committee suggest the presence of cyclical systemic risk: there is a risk that the banks underestimate the credit risks. The positive economic development in recent years has resulted in falling credit risks and a corresponding decline in risk provisioning and in risk-weighted assets for market risks. Credit defaults could increase in the event of an economic downturn. In such a scenario, both risk provisioning and risk-weighted assets would rise, placing a burden on banks’ capital ratios.

A further factor is that residential property prices have been rising for some time and, according to the Deutsche Bundesbank, that there are considerable overvaluations in urban districts. There is a risk here that loan collateral has been overvalued. An economic downturn could result in defaults on residential real estate loans and an increase in loss given defaults when liquidating real estate collateral, thus placing a burden on banks’ capital ratios.

Contrary to the arguments asserted during the consultation, the domestic countercyclical capital buffer is expressly not set on the basis of assumptions about loosening lending standards. In its explanatory remarks on the recommendation dated 27 May 2019, the Financial Stability Committee argues solely on the basis of actual risks. Actual risks result from significant price increases in the past that, in the estimation of the Deutsche Bundesbank¹¹ ,led to considerable overvaluations in urban districts. This results in substantial potential for setbacks. A general economic downturn and rising unemployment can lead to loan defaults. In such a scenario, banks that valued loan collateral too high in light of the aforementioned overvaluations run the risk of losses, since recoveries from loan collateral might not be sufficient to compensate for defaulted loans. This sub-risk is also addressed pre-emptively by raising the rate for the domestic countercyclical capital buffer. By contrast, the survey referred to in the consultation is aimed primarily at improving the supervisory data situation about lending standards. In BaFin’s view, the availability of data from the survey is therefore not decisive for substantiating the inventory risks and the use of capital-based measures.

Finally, the persistently low interest rates are contributing to the risk situation. This includes negative impacts on institutions’ income and an incentive to increase risk-taking on the one hand, as well as risks for funding costs and for the value of interest-bearing assets in the event of abrupt interest rate increases on the other hand.

To the extent that it was argued in the consultation that there were no interest rate risks that justify increasing the rate for the domestic countercyclical capital buffer, BaFin does not share this view. The explanatory remarks on the recommendation by the Financial Stability Committee state that the risks described, which are in some instances interdependent, collectively result in a scenario of a cyclical systemic risk.

The explanatory remarks on the recommendation by the Financial Stability Committee describe two possible interest rate scenarios that, when combined with the other risks, justify a cyclical systemic risk. They explain the scenario of an abrupt rise in interest rates on the one hand, and the scenario of a persistently low interest rate environment on the other. As explained above, persistently low interest rates are a drag on income from interest-based business and thus, over the longer term, on banks’ solvency as well. Additionally, weak earnings at banks give them an incentive, because of low interest margins, to increase their risk-taking and expand their lending in order to generate income. Such a scenario increases the risks to financial stability. In the case of the scenario of an abrupt rise in interest rates, funding becomes more expensive over the short to medium term, which can lead to an erosion especially in the value of fixed-rate assets.

Based on the risks described in the explanatory remarks on the recommendation by the Financial Stability Committee, BaFin holds the view that there are cyclical systemic risks that could impair financial stability. The increase of the countercyclical capital buffer is a preventive measure, based on the analysis of all available information in an overall assessment. As explained in the explanatory remarks to the recommendation, macroprudential measures are generally expected to have a preventive effect and hence strengthen the resilience of lenders to unexpected adverse events (shocks). The countercyclical capital buffer is thus a form of safety net in case the risks described above materialise, and its objective is to enhance the banks’ resilience.

The risks described above, some of which are interdependent, show that cyclical systemic risk is present.

If there is an economic downturn, there is a risk that banks will react with balance sheet measures if their loss absorbency is inadequate. If sufficient surplus capital is not available and if increasing capital through retained earnings or by borrowing from the market is not possible, curbs on lending to the real economy cannot be ruled out, especially if a number of affected institutions were to react in a similar way.

3. With regard to the calibration of the rate for the domestic countercyclical capital buffer at 0.25 per cent of the total risk exposure amount determined in accordance with Article 92(3) of Regulation (EU) No. 575/2013, BaFin concurs in full with and endorses point B.III. of the explanatory remarks on the recommendation by the Financial Stability Committee.

4. The increase in the rate for the domestic countercyclical capital buffer effective 1 July 2019 (applicable to the calculation of the institution-specific countercyclical capital buffer rate with effect from 1 July 2020) to 0.25 percent of the total risk exposure amount determined in accordance with Article 92(3) of Regulation (EU) No. 575/2013 is also proportionate.

As explained above, the increase in the rate for the domestic countercyclical capital buffer serves indirectly to strengthen the credit institutions’ capital base in times of economic growth, so that they have additional funds enabling them to absorb losses in stressed periods and hence serves to prevent the materialisation of system-wide risks.¹²

In the explanatory remarks on the recommendation, the Financial Stability Committee correctly observed that in particular no increase in microprudential minimum capital requirements can be considered for averting the risk to financial stability. In contrast to macroprudential buffers such as the countercyclical capital buffer, microprudential minimum capital requirements cannot be used by banks to absorb losses on a going-concern basis and are therefore not appropriate for achieving the objective.

BaFin also concurs with the statement in the explanatory remarks on the recommendation by the Financial Stability Committee dated 27 May 2019 that increasing microprudential minimum requirements is not an appropriate way of addressing cyclical systemic risk. It would be possible to adjust sectoral risk weights at least for the real estate sector via Articles 124 and 164 of the CRR. However, this would increase cyclical systemic risk in the short term – as described correctly in the explanatory remarks on the recommendation by the Financial Stability Committee dated 27 May 2019 – and additionally create wrong-headed incentives to shift lending business.

Furthermore, BaFin endorses the statements in the explanatory remarks on the recommendation by the Financial Stability Committee dated 27 May 2019 that it is not possible to capture cyclical systemic risks by means of an institution-specific Pillar 2 add-on. This is a microprudential instrument, not a macroprudential instrument and as such, is not aimed at cyclical systemic risk. Rather, an institution-specific Pillar 2 add-on aims at institution specific issues.

The increase in the rate for the domestic countercyclical capital buffer effective 1 July 2019 to 0.25 per cent of the total risk exposure amount determined in accordance with Article 92(3) of Regulation (EU) No. 575/2013 is also necessary to achieve the intended purpose. In line with the statements in the recommendation by the Financial Stability Committee dated 27 May 2019, BaFin does not see any milder but equally effective means.

Even if the approaches outlined above were to be suitable for addressing cyclical systemic risk, they would not impact the undertakings affected any less heavily. In order to address cyclical systemic risk using microprudential measures in a similar way to using macroprudential measures, the capital basis would also have to be strengthened in this case, with the result that the microprudential requirements would have to be calibrated overall to the same level. Besides, the consequences of breaching such a capital requirement would be potentially more serious than undershooting a capital buffer requirement.

The view was also advanced in the consultation that the target equity ratio already has a positive effect on financial stability because it is applied to all institutions. If this is meant to be an objection that an increase in the rate for the domestic countercyclical capital buffer is not necessary, BaFin does not concur with this view.

The target equity ratio is a soft microprudential capital requirement that does not have any direct legal effect. This capital requirement is calculated individually for each institution and should not therefore be confused with a macroprudential measure captured on a one-size-fits-all basis. Additionally, the countercyclical capital buffer is part of the combined buffer requirement (section 10i of the KWG) and therefore has direct legal consequences. For example, undershooting the combined capital buffer requirement automatically triggers dividend distribution restrictions.

It is also not necessary not to increase the rate for the domestic countercyclical capital buffer because many undertakings can already service the future additional capital (adequacy) requirements from surplus capital. As described in the preceding paragraph, the countercyclical capital buffer is part of the combined buffer requirement under section 10i of the KWG. By contrast, the institutions cannot be readily required under supervisory law to maintain capital over and above the legally stipulated own funds requirements.

Apart from that, no milder and equally effective means are apparent in order to address cyclical systemic risk.

Finally, increasing the rate for the domestic countercyclical capital buffer is also appropriate. Admittedly, the institutions concerned will be indirectly impacted by the measure because the rate for the domestic countercyclical capital buffer must be used to calculate the institution-specific countercyclical capital buffer rate under section 10d (2) of the KWG, and this means that the institutions concerned will have to comply with additional own funds requirements. However, according to BaFin’s findings, the institutions concerned will not be excessively burdened. As stated in the explanations in the Grounds under I. of this General Administrative Act, BaFin has performed calculations in this regard that have established that the additional own funds requirements can be borne overall by the institutions concerned, not least because they will have twelve months after the General Administrative Act is published to make any arrangements needed to comply with the additional own funds requirements. Furthermore, the burden on the institutions is counterbalanced by the prevention of severe risks to the financial system as a whole.

The concerns voiced in the consultation that the measure could have a procyclical effect do not affect the appropriateness of the measure. As explained in the explanatory remarks on the recommendation by the Financial Stability Committee, the German economy remains on a growth path, despite the current economic gloom. The explanatory remarks also set out that the appropriateness of the countercyclical capital buffer will be subject to quarterly review and that the buffer will be adjusted if necessary. This also applies to the twelve-month phase-in period for the countercyclical capital buffer. Consequently the rate for the domestic countercyclical capital buffer can be adjusted each quarter, enabling a quick response to potential negative developments.

However, BaFin continues to take the view that increasing the countercyclical capital buffer will increase the resilience of the banking system and hence reduce the probability of procyclical reactions by the banking system in an economic downturn scenario. It is not evident in the present situation that thebuild-up of additional capital will cause negative procyclical effects.

Re number 2

The initial application date was determined on the basis of section 10d (4) sentence 1 of the KWG. The period of 12 months results from section 10d (4) sentence 2 of the KWG.

Re number 3

The group of addressees results from section 10d (1) of the KWG and section 2 (9c), (9e), (9g) and (9h) of the KWG.

Re number 4

The timing of the announcement is based on section 17 (2) of the Act Establishing the Federal Financial Supervisory Authority (Gesetz über die Bundesanstalt für Finanzdienstleistungsaufsicht – Finanzdienstleistungsaufsichtsgesetz – FinDAG) in conjunction with section 41 (4) sentence 4 of the Administrative Procedure Act (Verwaltungsverfahrensgesetz – VwVfG).

Instruction on available remedies

Objections to this notice can be submitted to the Federal Financial Supervisory Authority in Bonn or Frankfurt am Main within one month of its announcement.

Raimund Röseler

This translation is furnished for information purposes only. The original German text is binding in all respects.

Footnotes

1 On the one hand, the national method for calculating the credit-to-GDP gap only considers loans by domestic MFIs (banks and money market funds) to the non-financial sector, and on the other, the buffer guide is not increased if the annual GDP growth rate is negative (i.e. there is a recession). The reason for the first modification is the long history of the MFI credit time series (back to 1968) and the availability of data adjusted for statistical breaks (e.g. German reunification). The idea behind the second modification is not to increase the buffer guide in an economic downturn and thus curb lending in such a phase.
2 IMF Mission Concluding Statement 17 May 2019 https://www.imf.org/en/News/Articles/2019/05/17/Germany-Staff-Concluding-Statement-of-the-2019-Article-IV-Mission
3 see “Basel III: A global regulatory framework for more resilient banks and banking systems”, paragraph 136 et seq.
4 see “Basel III: A global regulatory framework for more resilient banks and banking systems”, paragraph 136; Recitals 79 to 82 of the CRD.
5 see Recital 80 of the CRD.
6 see Recital 81 of the CRD
7 see also Recital 1 of ESRB/2014/1.
8 see e.g. Mian and Sufi (2014), House of Debt, University of Chicago Press; Detken et al. (2014), Operationalising the Countercyclical Capital Buffer: Indicator Selection, Threshold Identification and Calibration Options, ESRB Occasional Paper Series, No. 5, June 2014; Roy and Kemme (2011), What is Really Common in the Run-up to Banking Crises? Economics Letters, Vol. 113, pages 211-214; Barrell et al. (2010), Bank Regulation, Property Prices and Early Warning Systems for Banking Crises in OECD Countries, Journal of Banking and Finance, Vol. 34, pages 2255–2264.
9 IMF World Economic Outlook Database, April 2019
10 see methodological note, page 15.
11 Deutsche Bundesbank, Monthly Report February 2019, page 57.
12 see Recital 80 of the CRD.

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Erscheinung:04.09.2019 | Reference number R 1-AZB 1134-2019/0001 | Topic Macroeconomic supervision, Own funds General Administrative Act governing the rate for the domestic countercyclical capital buffer under section 10d of the KWG

General Administrative Act:

Grounds:

I.

Credit-to-GDP Gaps

II.

Re number 1:

Re number 2

Re number 3

Re number 4

Instruction on available remedies

Additional information

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Erscheinung:04.09.2019 | Reference number R 1-AZB 1134-2019/0001 | Topic Macroeconomic supervision, Own funds General Administrative Act governing the rate for the domestic countercyclical capital buffer under section 10d of the KWG

General Administrative Act:

Grounds:

I.

Credit-to-GDP Gaps

II.

Re number 1:

Re number 2

Re number 3

Re number 4

Instruction on available remedies

Additional information

More on this topic

Did you find this article helpful?

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