Provision of a general nature on setting the countercyclical capital buffer rate for the Czech Republic No. II/2022

of 16 June 2022

on setting the countercyclical capital buffer rate for the Czech Republic No. II/2022

Pursuant to Article 12o(5) of Act No. 21/1992 Coll., on Banks, as amended by Act No. 375/2015 Coll., (hereinafter referred to as the "Act on Banks") and Article 8al(5) of Act No. 87/1995 Coll., on Credit Unions and Certain Related Measures and on the Amendment of Czech National Council Act No. 586/1992 Coll., on Income Taxes, as amended, as amended by Act No. 375/2015 Coll. (hereinafter referred to as the "Act on Credit Unions"), the Czech National Bank as a competent administrative body hereby issues the following provision of a general nature:

1. Pursuant to Article 12o(3) of the Act on Banks and Article 8al(3) of the Act on Credit Unions, the countercyclical capital buffer rate for the Czech Republic shall be set at 2.50% of the total risk exposure amount pursuant to Article 92(3) of Regulation (EU) No. 575/2013 of the European Parliament and of the Council.
2. Banks and credit unions shall apply the rate referred to in point I for the purposes of calculating the combined buffer requirement as from 1 July 2023.

Justification

1. Pursuant to Article 12o(3) of the Act on Banks and Article 8al(3) of the Act on Credit Unions, the Czech National Bank (hereinafter referred to as the "CNB") shall set the countercyclical capital buffer rate for the Czech Republic, taking into account the countercyclical capital buffer guide calculated pursuant to Article 12o(1) and (2) of the Act on Banks and Article 8al(1) and (2) of the Act on Credit Unions, the recommendations issued by the European Systemic Risk Board (hereinafter referred to as the "ESRB") and indicators which may imply growth in systemic risk.
2. Pursuant to Article 12o(1) of the Act on Banks, Article 8al(1) of the Act on Credit Unions and Article 9al(1) of the Capital Market Undertakings Act, the calculation of the buffer guide is based on the deviation of the credit-to-GDP ratio from its long-term trend - the credit-to-GDP gap. The credit-to-GDP ratio was 86.2% and the relevant deviation from the long-term trend -6.1 percentage points in 2021 Q4.^[1] This value pursuant to Article 12o(1) of the Act on Banks and Article 8al(1) of the Act on Credit Unions corresponds to a benchmark countercyclical capital buffer rate of 0%. The additional gap,^[2] which is based on the ESRB Recommendation (section B, Article 2) and better reflects the specificities of the Czech economy, was 4.4 percentage points in 2021 Q4 and implies a benchmark rate of 0.75%.
3. In reaction to the ESRB recommendation, the CNB has repeatedly emphasised in its publications (particularly the Financial Stability Report) that it does not regard the size of the gaps referred to in paragraph 2 as a reliable guide for determining the position of the domestic economy in the financial cycle and setting the rate. The CNB prefers an approach based on a comprehensive assessment of indicators identifying growth in systemic risks under Article 12o(3) of the Act on Banks and Article 8al(3) of the Act on Credit Unions.^[3]
4. The value of the financial cycle indicator (FCI) increased in year-on-year comparison in 2021 Q4 but recorded its second consecutive decline in quarter-on-quarter terms due to a drop in the correlation between the individual manifestations of the financial cycle. However, the theoretical FCI value (abstracting from the strength of the correlation) also increased significantly quarter on quarter and was the highest since 2009. Debt financing of residential property purchases accompanied by accelerating growth in residential property prices remains the main source of this growth. The strong price growth and, on the other hand, an increase in interest rates on house purchase loans and a decrease in growth in household income have led to a rise in the estimated overvaluation of apartment prices for the median household to above 40%. According to the CNB's estimate, the overvaluation of investment apartments also exceeded 40% and was the highest in history. Strong lending activity could be observed not just for loans to households for house purchase, but also for loans to households for consumption and loans to non-financial corporations. The growth rates in all three credit segments remained above their short-term, medium-term and long-term averages. Overall growth in loans to the private non-financial sector thus rose by 6.1 pp to 9.3% in March 2022.^[4] This led to a continued build-up of cyclical risks in the banking sector. In line with the CNB's current forecast, the build-up of cyclical risks in the banking sector's balance sheets can be expected to peak in the course of 2022. Exceptionally low provisioning and a drop in the ratio of provisions to total loans meanwhile indicate that the banking sector may be insufficiently prudent in assessing the accumulated risks. Lowered risk weights in the loan portfolios of banks applying the IRB approach also remain a source of systemic risk. A deterioration in risk parameters as a result of adverse cyclical effects would lead to a rise in risk weights, and indirectly also in the capital requirement in absolute terms, which should be covered by the countercyclical capital buffer. The estimated capital needed to cover the fall in the capital ratio as a result of risk weights returning to higher levels (around CZK 30.9 billion according to the CNB's estimates), together with unexpected credit losses (around CZK 22.4 billion according to the CNB's estimates), imply a need for additional capital of CZK 53.3 billion, which would be fully covered by a buffer rate of 2.00%. However, the escalation of the Russia-Ukraine conflict and the increased geopolitical uncertainty is creating potential for faster and more substantial materialisation of cyclical risks than the baseline estimate assumes, hence the CNB prefers a higher degree of prudence in setting the buffer rate.
5. Based on the above assessment, and taking into account the potential consequences of Russia's aggression towards Ukraine on the extent and speed of materialisation of cyclical risks, the CNB Bank Board has decided to set the countercyclical capital buffer rate at 2.50%, which is the level necessary to ensure that the banking sector is resilient to these risks.^[5] Should the economic situation worsen and significant unexpected credit losses form in the domestic banking sector, the CNB is ready to lower the buffer rate or release the buffer fully in order to support banks' ability to provide credit to the real economy without interruption.
6. Pursuant to Article 12x(1) of the Act on Bank and Article 8au(1) of the Act on Credit Unions, this provision of a general nature is announced only in a manner facilitating remote access and takes effect on the day of its publication.

Effect

This Provision shall take effect on 17 June 2022.

Tomáš Nidetzký Deputy Governor

Jan Frait Executive Director, Financial Stability Department

This provision of a general nature was published on 17 June 2022.

^[1] In accordance with ESRB Recommendation 2014/1 (Recommendation of the European Systemic Risk Board of 18 June 2014 on guidance for setting countercyclical buffer rates), total credit means the value of all loans provided to the private sector (non-financial corporations, households and non-profit institutions serving households) plus the volume of bonds issued by the domestic private sector. The time series of 1995 Q1-2021 Q4 and the Hodrick-Prescott filter with a smoothing parameter (λ) of 400,000 are used to calculate the long-term trend of the credit-to-GDP ratio.

^[2] The additional gap - the expansionary credit gap - is calculated as the difference between the current ratio of bank loans to gross value added of the private non-financial sector and the minimum level of this ratio achieved in the past eight quarters.

^[3] The methodological framework of the Czech National Bank for setting the countercyclical buffer rate is presented in the document The CNB's approach to setting the countercyclical capital buffer.

^[4] The annual growth rates of bank loans provided to households for house purchase and for consumption were 11.1% and 8.9% respectively in March 2022. Bank loans to non-financial corporations increased by 7.6% year on year in March 2022.

^[5] The institutions concerned shall apply a countercyclical capital buffer rate of 2.50% of the total risk exposure for the purposes of calculating the combined buffer requirement as from 1 April 2023. They shall apply a rate of 2.00% for the purposes of calculating the combined capital buffer from 1 January 2023 to 31 March 2023. They shall apply a rate of 1.50% for the purposes of calculating the combined capital buffer from 1 October 2022 to 31 December 2022. They shall apply a rate of 1.00% for the purposes of calculating the combined capital buffer from 1 July 2022 to 30 September 2022. They shall apply a rate of 0.50% for the purposes of calculating the combined capital buffer until 30 June 2022.