Supervisory measures in reaction to the Corona crisis – Minimum capital ratios

Minimum capital ratios

The following blog post is part of the overview of supervisory measures in reaction to the Corona crisis:Supervisory measures in reaction to the Corona crisis – Overview.

According to the ad hoc measures taken by the ECB, banks can fully use their capital buffers during this time of financial distress, including the Capital Conservation Buffer (CCB) and the Pillar 2 Guidance (P2G). This means that banks are allowed to operate temporarily – until further notice – below the level of capital defined by the P2G and the CCB. 

Besides, banks can partially use capital instruments that do not qualify as CET1 capital, e.g. Additional Tier 1 or Tier 2 instruments, to meet their Pillar 2 Requirement (P2R). This measure is effectively an early implementation of the standards laid down in CRD V that originally should entry into force in January 2021). Banks will therefore benefit from relief in the composition of capital for the P2R.

Furthermore, the country-specific countercyclical buffer (CCyB) can be reduced individually by the competent national authorities. In Germany for example, the competent authority for setting the CCyB (Ausschuss für Finanzstabilität, ASF) already announced on March 18, 2020, that the CCyB rate for exposures in Germany would be set to 0% from April 2020 (instead of 0,25% which would have been effective from July 2020 onwards according to BaFin’s Allgemeinverfügung). This reduction will expire in December 2020 or maybe prolonged. Other national competent authorities went the same way and reduced their current CCyB rate or revoked their decision to increase the CCyB rate in the near future. Please find below an overview of the CCyB adjustments due to the COVID-19 crisis (as of March 27, 2020): (please click to enlarge)

 

The ECB highlights that the absorption of the P2G and the amended capital composition for the P2R will lead to a CET1 relief for the significant banks of € 120 bn which can be used to absorb losses or to finance the real economy. Please find below an overview of the minimum capital ratios including the “Corona” buffers that can be used.(please click to enlarge).

This number is based on average capital requirements for credit risk. The actual amount of additional capital that can be used to extend further credit business however depends on a number of factors which banks need to analyse in order to adjust their loan origination to the Corona crisis as well as the countermeasures being discussed. For banks using the standardized approach for credit risk, possible effect of the Coronavirus focus on the amount of credit risk adjustments, value of collateral, number of new defaults and rating migration leading to increased risk weights: (please click to enlarge)

 

Banks using the IRB approach will have to face similar topics, however with some added complexity. For example, the additional credit risk adjustments are partly countered by the comparison with expected loss amounts, that will also increase as a consequence of the crisis. (please click to enlarge)

A rise in defaults will be reflected in the PD estimation while declining collateral values will be reflected to a lower extent in the LGD, given that banks are already required to use LGD estimates calibrated on an economic downturn: (please click to enlarge)

As a conclusion, banks need to analyse continuously the individual impact on RWA and capital requirements resulting from the crisis and the various measures taken, including:

  • Assessing the CET1 capital relief, resulting from the several reductions as well as the reduced CET1 requirement for P2R..
  • Calculating the new CCyB based on all recent changes
  • Simulating / assessing the RWA effects
  • Simulating / assessing of CET1 effect (EL comparison)

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