EBA欧洲银行-20131217-Report-on-the-pro-cyclicality-of-capital-requirements-under-the-IRB-Approach_43页_1mb

Summary of the Report on the Pro-Cyclicality of Capital Requirements under the Internal Ratings Based Approach

Core Content

This report evaluates whether the Capital Requirements Regulation (CRR) and Capital Requirements Directive IV (CRD IV) have a pro-cyclical effect on the financial system, as mandated by Article 502 of the CRR. Pro-cyclicality is defined as the dynamic interactions between the financial and real sectors that amplify business cycle fluctuations and may cause or worsen financial instability. The focus is on banks using the Internal Ratings Based (IRB) Approach, as their capital requirements are inherently risk-sensitive, based on input parameters such as Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD).

The report combines empirical analysis and a literature review to assess the potential pro-cyclical effects of capital requirements. It highlights the complexity of the relationship between capital requirements, lending behavior, and the real economy, especially in the context of the recent financial crisis.

Main Findings

1. Pro-Cyclicality and Cyclicality

• Pro-cyclicality refers to the amplification of the economic cycle by financial institutions.
• Cyclicality is the natural adjustment of capital requirements to the economic cycle, which does not imply amplification of the cycle itself.
• The report distinguishes between these two concepts, emphasizing that the focus is on pro-cyclicality.

2. Pro-Cyclicality of IRB Banks

• IRB banks that use Point-in-Time (PIT) PDs exhibit significant variations in capital requirements from peak to trough, which can be pro-cyclical.
• In contrast, Through-the-Cycle (TTC) PDs are more stable and less cyclical.
• The literature suggests that capital requirements under Basel II are more risk-sensitive than under Basel I, potentially increasing pro-cyclicality.

3. Empirical Evidence from ISG Database

• The ISG dataset, covering banks from 12 countries with semi-annual data from H2 2008 to H2 2012, is used for analysis.
• A balanced sample of 60 banks is used to ensure consistency in time series analysis.
• Key Observations:
  • The average solvency ratio of European banks improved from 11.5% to 14.5%.
  • Risk-weighted assets (RWA) showed a clear cyclical pattern.
  • Minimum Capital Requirements (MCR) declined by 2.36% over the sample period, partly due to capital injections and portfolio adjustments.

4. Impact of Provisions on Capital Requirements

• Provisions are intended to cover expected credit losses (EL).
• If provisions are insufficient (negative Regulatory Calculation Difference or RCD), capital must act as a buffer.
• A positive RCD (excess provisions over EL) is added to regulatory capital (Tier 2) up to a maximum of 0.6% of RWA under the IRB Approach.

5. Empirical Results

• The descriptive statistics show a shift towards lower-risk portfolios, with an increase in retail and sovereign exposures and a decrease in bank and corporate exposures.
• The econometric analysis reveals statistically significant negative correlations between capital requirements and the macroeconomic environment.
• This suggests that capital requirements may influence lending behavior and amplify economic cycles.
• However, the relationship is not clear-cut, and the findings are influenced by the recent financial crisis.

6. Pro-Cyclicality Mitigation

• The report discusses the role of counter-cyclical capital buffers (CCB), which are part of Basel III.
• It also suggests that dynamic provisioning and Pillar 2 (supervisory review process) can help mitigate pro-cyclicality.
• Smoothing mechanisms, such as applying a time-varying multiplier to PD estimates, are proposed to reduce the pro-cyclical effect.

Key Information

Data Sources

• ISG dataset: Contains semi-annual data from H2 2008 to H2 2012.
• Euro Area Bank Lending Survey (BLS): Used to assess the impact of regulatory changes on lending behavior.

Methodology

• Descriptive statistics: Analyzed the distribution of capital requirements and risk parameters across portfolios.
• Econometric analysis: Used regression models to assess the correlation between capital requirements and macroeconomic indicators.

Policy Recommendations

• Transparency and documentation: Banks should provide more detailed information on their rating philosophy, PD calculation, and back-testing methodology.
• Convergence of methodologies: The EBA is encouraged to ensure that IRB methodologies converge to reduce pro-cyclicality.
• Implementation of CCB: As part of Basel III, the counter-cyclical capital buffer is recommended to mitigate the pro-cyclical effects of capital requirements.

Conclusion

The report concludes that the pro-cyclicality of capital requirements is weak and that a clear causal link between capital requirement regulation and the economic cycle has not been established. However, the risk-sensitivity of the IRB Approach and the use of PIT PDs can contribute to pro-cyclical behavior. The report recommends further research and policy measures to reduce the pro-cyclical effects, particularly through the implementation of counter-cyclical buffers and improved transparency in capital requirement methodologies.