Recommendation FMSB/5/2021: guidance on applying the countercyclical capital buffer (CCyB)

The latest recommendation of Austria’s Financial Market Stability Board (FMSB) to the Financial Market Authority (FMA), in line with Article 23a para. 1 of the Austrian Banking Act, is to leave the countercyclical capital buffer (CCyB) unchanged at a rate of 0% of risk-weighted assets. This decision will apply from April 1, 2022, and will be reviewed once property-related measures have taken effect.

The main indicator (credit-to-GDP gap) and additional indicators informing this decision continue to be elevated. The credit-to-GDP gap has been above 2% since the second quarter of 2020, which would imply that CCyB requirements are called for. However, more recently the gap narrowed from 8.0% in the first quarter of 2021 to 2.9% in the second quarter of 2021 in line with the recovery of output growth. Moreover, the additional indicator has been stagnating at a level that is comparatively low by historical standards, signaling substantial financial market mispricings, increased risk-taking by banks and a significant overvaluation of property prices. The additional indicator is based on an aggregation of indicators relating to mispricing in the financial system, risk mispricing, the soundness of bank balance sheets, credit growth, property prices and the current account balance. In particular, the risk weights of mortgage-backed loans and corporate loans are at historically low levels, even if they have been on the rise more recently. Finally, insolvencies have decreased markedly compared to pre-pandemic 2019 levels thanks to government support measures, but patterns are increasingly normalizing judging from incoming data.

Studies refute the case for changing the CCyB mechanistically in line with a given credit-to-GDP gap, in particular when this gap is caused by a negative business cycle (Baba et al., 2020; Drehmann et al., 2011 and 2014). In Austria, economic activity reverted to positive year-on-year growth (+0.7%) from the second quarter of 2020 to the second quarter of 2021, but the outlook for GDP growth remains fragile. Hence the FMSB recommends a CCyB of 0% for the time being, but also emphasizes that credit growth is still too high compared with GDP growth.

Any future decision on whether a higher CCyB requirement would be advisable will depend on whether the CCyB-relevant indicators continue to see a sustained improvement as the economy recovers. Among the indicators monitored, special attention is given to credit growth, banks’ risk appetite, household and corporate indebtedness and uncertainty surrounding economic developments. Another factor that feeds into the decision-making on activating a CCyB is how effective property-related measures are in reducing the risks arising from the credit cycle.

Therefore, the importance of the credit-to-GDP gap would need to be counterbalanced by giving more weight to the indicators listed above as the economy recovers. After all, the risks arising from the credit cycle will not necessarily evaporate even if the credit-to-GDP gap closes when output growth rises.