FINANCIAL STABILITY
Macroprudential Policy
Introduction
The Central Bank of Armenia pursues a
macro-prudential policy in order to maintain and enhance financial
stability. In practice, macro-prudential policies involve identification of
systemic risks, such as selecting and applying macro-prudential tools to
mitigate or neutralize those risks, which will contribute to the
strengthening of financial stability.
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Rational Countercyclical Capital Buffer
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Macro-prudential policy concept
Intermediate goals of macro-prudential policy
The
effective choice of macro-prudential instrument(s) is based on the
intermediate objectives of the macro-prudential policy; these, in essence,
describe the possible sources of systemic risk exposure. That is, first the
possible sources of risks are assessed, their relative strength, from which
the specific intermediate goal(s) of the macro-prudential policy will be
targeted and the appropriate macro-prudential tool(s) selected.
The main intermediate
goals of macro-prudential policy include:
- Mitigate or prevent excessive growth of lending or
excessive leverage
- Mitigate or prevent excessive maturity mismatch and liquidity problems
- Limit the risk of concentration
- Limit the systemic impact of false stimuli and reduce the risk of moral
hazard.
Macro-prudential tools
- Counter-cyclical capital buffer
- Capital conservation buffer
- Lending restrictions on real estate-secured loans
- Capital requirement for systemically important financial institutions
Counter-cyclical capital buffer
The use of a counter-cyclical capital buffer was proposed by the Basel
Committee on Bank Supervision under Basel III. The procedure for “Setting
and Calculating Thresholds above the Capital Adequacy Ratio of Banks”
approved by the Board of the Central Bank of Armenia has been effective
since April 1, 2019. The procedure establishes, among other thresholds, the
counter-cyclical threshold of capital (hereinafter counter-cyclical capital
buffer).
The
counter-cyclical capital buffer is intended to increase the ability of the
financial system to withstand financial and economic shocks and to ensure
the smooth flow of financial resources provided to the economy through
lending.
The
counter-cyclical capital buffer targets the excessive (risky) growth of
loans by mitigating the negative effects it would have on the stability of
financial system. To curb the excessive growth of loans, the Central Bank
raises the capital requirement when the financial cycle is upward, creating
an additional buffer. When the financial cycle is downward, the buffer will
decrease, so that financial institutions will be able to cover losses,
thereby reducing the need for large-scale lending by financial system
participants (deleveraging), and its adverse effects on financial stability
and economic growth.
The
Central Bank makes decisions on the counter-cyclical capital buffer every
quarter. The deciding on the counter-cyclical capital buffer by the Central
Bank of Armenia is detailed in the paper “General Methodology for Setting
the Counter-Cyclical Capital Threshold”.
Counter-cyclical capital buffer rate
Capital
conservation buffer
The capital
conservation buffer assumes (is designed in such a way) that the financial
institution must accumulate the required amount of capital over its
activity, which can be used to cover possible losses in a stressful
situation.
The procedure
for “Setting and Calculating Thresholds above the Capital Adequacy Ratio of
Banks” (CBA Board resolution No: 16-N, dated February 4, 2019) defines the
required rates for a capital conservation threshold (buffer) and the
timetable, as follows:
- From January 1,
2020 to December 31, 2020 (inclusive) - at the rate of 0.5%
- From January 1, 2021 to December 31, 2021 (inclusive) - at the rate of 1%
- From January 1, 2022 to December 31, 2022 (inclusive) - at the rate of 1.5%,
- From January 1, 2023 to December 31, 2023 (inclusive) - at the rate of 2%,
- Since January 1, 2024 - at the rate of 2.5%.
Lending restrictions on real estate-secured loans
Unlike
other macro-prudential tools that assume a capital related requirement, this
group of macro-prudential tools assumes a credit related requirement/offer
to the borrower for a change in lending terms. In international practice,
the maximum limits on loan-to-debt, debt to income and debt service to
income ratios are widely used. Central banks use such types of
macro-prudential tools to address, in particular, the imbalances in mortgage
loans and real estate market, and the resultant accumulation of systemic
risks.
Capital requirement for systemically important banks
The
additional capital requirement for systemically important banks is intended
to reduce the likelihood of systemic risk, which may arise from possible
destabilization of these banks, by enhancing the resilience of such banks
and their ability to withstand various types of shocks. The destabilization
of systemically important banks can impair an efficient functioning of the
banking system, which in turn can negatively affect the financial system and
real economy on the whole.
According to the Basel Committee, in order to determine if a bank is
systemically important, one should take into account the possible amount of
damage (impact) the bank would cause to the financial system, once turned
insolvent, rather than the probability that the bank may become insolvent.
Each
year, the Central Bank of Armenia approves, under a relevant governor
decision, the list of banks that are considered to be of systemic
importance.
Determination of systemically important banks is based on the following
group of features: size, affiliation, interchangeability, complexity and
other specificities peculiar to the Armenian financial system (Guide for
Determination of Systemically Important Banks).
The
procedure for “Setting and Calculating Thresholds above the Capital Adequacy
Ratio of Banks” (CBA Board resolution No: 16-N, dated February 4, 2019)
defines the rates for systemically important banks threshold and the
timetable, as follows:
- From January 1, 2020 to December 31, 2021
(inclusive) - at the rate of 0.5%
- From January 1, 2022 to December 31, 2022 (inclusive) - at the rate of 1%
- Since January 1, 2023 - at the rate of 1.5%.