A precautionary risk management tool (part of the Basel III agreement) that is used to promote the build-up of capital in good times so that it can be drawn upon in periods of financial stress or turmoil, hence reducing the procyclicality of the banking industry.
The capital buffers, a range of 0-2.5% of common equity or other fully loss absorbing capital, are typically designed to remove any excess cyclicality of regulatory capital, promote more forward-looking provisions, conserve capital to build reserves that can be used in hardship times, and achieve the broader macro-prudential goal of protecting the banking sector from periods of excess or rampant credit growth. In other words, the countercyclical capital buffer (CCB) aims to ensure that banking sector capital requirements take account of the surrounding macro-financial environment. It is typically applied by national jurisdictions when excess aggregate credit growth is seen to be associated with a build-up of system-wide risk. This will help ensure the banking system has a buffer of capital to protect it against future potential losses. Individual banks and investment firms are required to build up capital during periods of over-exuberance in order to increase the resilience of the financial system and to slow the credit cycle.
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