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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.
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.
Counter-cyclical capital buffer rate
Board decisions on Countercyclical Capital Buffer
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.
The CBA has set caps of loan-to-value ratios (LTV) as prudential standards (N51 and N52) which are in force from April 1, 2022. The LTVs apply to the loans that are secured by real estate and are differentiated by the currency of loan:
- for AMD denominated loans the maximum size of LTV is set to 90%
- for FX denominated loans the maximum size of LTV is set to 70%
- It is allowed to provide some amount of loans that do not meet the abovementioned requirements. For AMD and FX loans, respectively, the amount of loans with LTV ratio higher than maximum caps can be maximum 10% and 5% of the average of quarterly sums of real estate secured loans, that were granted by a bank during previous two quarters.
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%.
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