Eesti Pank introduced a capital buffer requirement for banks that responds to the credit cycle
- The countercyclical capital buffer will reduce the risks of rapid credit growth at the banks and the chances of a credit boom occurring
- The buffer rate is being set at 0% in Estonia for now as credit growth is in line with GDP growth
- The central bank will assess the need for the countercyclical capital buffer once a quarter
- Capital requirements for systemically important banks will be decided next year
- Eesti Pank has already introduced a systemic risk buffer requirement and requirements for issuing housing loans
Eesti Pank introduced a countercyclical capital buffer requirement that will apply from 1 January 2016 and will reduce the risks of rapid credit growth for the banks. Credit growth is currently in line with GDP growth and so Eesti Pank has set the capital buffer rate in Estonia at 0%.
The aim of the countercyclical capital buffer requirement is for banks to build up additional capital at times when credit is growing fast so that they can then use it to cover possible losses during a later cyclical downturn. The higher capital requirements set during times of rapid growth can also help to slow the growth in credit and restrain rises in asset prices.
Eesti Pank will start to assess once a quarter whether changes in the credit cycle make it necessary to change the capital buffer rate. This assessment will draw largely on pre-determined indicators that describe loan growth, indebtedness and rises in real estate prices and changes in the risk behaviour of borrowers or the financial sector.
The countercyclical capital buffer requirement is one of the macroprudential tools in the European Union’s Capital Requirements Directive, which member states must apply in order to support financial stability. These buffer rates also apply cross-border, meaning that foreign banks that operate in the Estonian credit market through branches or that have direct cross-border credit risk exposures here must also observe the rates required by Eesti Pank when calculating their own funds requirements. Equally, banks from Estonia must follow the countercyclical capital buffer rates set by other countries, such as those in Sweden and Norway, which are currently 1% but will rise to 1.5% in the second quarter of next year.
Eesti Pank has taken a series of steps to reduce the chances of a credit boom inflating in the future and to make the banking sector more resilient. The central bank introduced three requirements for housing loans this March, which protect both borrowers and banks against excessive risk. Last year a systemic risk buffer was introduced for banks to address the vulnerabilities stemming from the small size and the openness of the Estonian economy.
The next step is for Eesti Pank to assess in the first half of 2016 what additional capital buffer requirements should be introduced for systemically important banks in Estonia. Eesti Pank has currently named two banks as systemically important credit institutions for the Estonian financial system: Swedbank AS and AS SEB Pank. Credit institutions are systemically important if the functioning of the Estonian economy and financial system would be seriously threatened by them running into difficulties. Their importance may stem from their size, their complexity or their interdependence with other participants in the financial system.
Eesti Pank’s assessment of the countercyclical capital buffer, the indicators used in the analysis, and the assessment methodology can be found on the Eesti Pank website.