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Accelerated systemic cushion

What Is Accelerated Systemic Cushion?

An Accelerated Systemic Cushion, often referred to as a Countercyclical Capital Buffer (CCyB), is a macroprudential policy tool used by financial regulators to enhance the resilience of the banking system against systemic risks. It is a capital requirement that fluctuates with the economic cycle, designed to compel banks to build up a larger capital base during periods of excessive credit growth and release it during economic downturns. This mechanism falls under the broader category of macroprudential finance. The purpose of the Accelerated Systemic Cushion is to safeguard financial stability by ensuring that banks have sufficient capital to absorb potential losses, thereby mitigating the risk of credit crunch during crises. The concept of an Accelerated Systemic Cushion is crucial for maintaining a healthy flow of credit to the economy.

History and Origin

The concept of countercyclical capital buffers gained prominence following the 2007-2009 global financial crisis, which exposed vulnerabilities in the global banking system. Regulators recognized the need for tools to address the procyclicality of the financial system, where the financial sector amplifies economic booms and busts. In December 2010, the Basel Committee on Banking Supervision (BCBS) introduced the countercyclical capital buffer as a key component of the Basel III regulatory framework.30, 31 This framework, agreed upon by central banks worldwide, aimed to strengthen bank capital adequacy and liquidity.28, 29 The Bank for International Settlements (BIS) has consistently supported the use of such macroprudential instruments to address procyclicality.27 The Federal Reserve articulated its framework for setting the CCyB for U.S.-based credit exposures in 2016.26

Key Takeaways

  • The Accelerated Systemic Cushion, or Countercyclical Capital Buffer (CCyB), is a macroprudential tool.
  • It requires banks to increase their capital reserves during economic expansions and allows them to release capital during contractions.
  • The primary goal is to protect the banking sector from systemic risk and ensure a stable supply of credit.
  • The CCyB was introduced as part of the Basel III international regulatory framework.
  • Its effectiveness is debated, with some arguing it can constrain lending or shift risk.

Formula and Calculation

The Accelerated Systemic Cushion is typically expressed as a percentage of a bank's risk-weighted assets (RWA). The specific rate for the buffer is determined by national authorities based on their assessment of macro-financial conditions and systemic risk.

For example, if the required Accelerated Systemic Cushion is 1% and a bank has $100 billion in risk-weighted assets, the additional capital required would be:

Additional Capital=CCyB Rate×Risk-Weighted Assets\text{Additional Capital} = \text{CCyB Rate} \times \text{Risk-Weighted Assets}
Additional Capital=0.01×$100,000,000,000=$1,000,000,000\text{Additional Capital} = 0.01 \times \$100,000,000,000 = \$1,000,000,000

This additional capital must be held in the form of Common Equity Tier 1 (CET1) capital, which is the highest quality of bank capital.25

Interpreting the Accelerated Systemic Cushion

The level of the Accelerated Systemic Cushion signals the perceived state of systemic risk within an economy. When the buffer is increased, it indicates that regulators believe there is an elevated risk of above-normal future losses due to excessive credit growth or other vulnerabilities. Conversely, a reduction or release of the buffer suggests that economic conditions are deteriorating, and the aim is to support lending and overall economic activity by allowing banks to utilize their capital cushion.24

The buffer operates as an extension of the capital conservation buffer and helps ensure that banking sector capital requirements account for the prevailing macro-financial environment.23 By raising capital requirements during expansions, it aims to protect the financial system from the build-up of systemic risk.22

Hypothetical Example

Consider a hypothetical country, "Prosperia," experiencing a sustained period of robust economic growth, low unemployment, and rapidly expanding credit. The financial regulators of Prosperia observe that banks are increasing their lending significantly, particularly in sectors like real estate, and asset prices are rising quickly. To preempt a potential future financial crisis caused by an overheated economy and excessive leverage, the central bank decides to implement an Accelerated Systemic Cushion of 1.5%.

This means that all nationally active banks in Prosperia must now hold an additional 1.5% of their risk-weighted assets as Common Equity Tier 1 capital. For "Prosper Bank," with $50 billion in risk-weighted assets, this translates to an additional capital requirement of (0.015 \times $50,000,000,000 = $750,000,000). This measure encourages banks to be more prudent in their lending and builds a buffer for potential future losses, thus strengthening the bank's balance sheet and improving its solvency.

Practical Applications

The Accelerated Systemic Cushion is a core tool within the broader framework of macroprudential policy. Its practical applications include:

  • Financial Stability: It acts as a defense mechanism to absorb losses during downturns, thereby enhancing the overall stability of the financial system.20, 21
  • Mitigating Procyclicality: By requiring banks to build capital in good times, it helps to lean against the build-up phase of the credit cycle and can reduce the procyclicality of credit supply.19
  • Credit Supply Management: Releasing the buffer during economic stress aims to support the continued supply of credit to businesses and households, preventing a severe credit crunch.18
  • International Coordination: The framework for the Accelerated Systemic Cushion is part of international standards (Basel III), promoting global financial stability through coordinated regulatory efforts. The Bank for International Settlements (BIS) regularly publishes a dashboard showing buffer decisions across jurisdictions.17

Limitations and Criticisms

While intended to bolster financial stability, the Accelerated Systemic Cushion faces several limitations and criticisms:

  • Timing Challenges: Accurately identifying the peak of the credit cycle and the optimal time to activate or release the buffer can be challenging.16 Misjudging the timing could exacerbate economic fluctuations.
  • Economic Impact on Lending: Critics argue that raising capital requirements, even in good times, could reduce lending to businesses and households, potentially hindering economic growth.15 This could disproportionately affect bank-dependent borrowers, such as small businesses.14
  • Risk Shifting: Imposing higher capital requirements on regulated banks might inadvertently shift financial activity to less regulated sectors, creating new avenues for systemic risk.13
  • Blunt Instrument: The Accelerated Systemic Cushion is considered a relatively blunt instrument, as it applies broadly across all assets rather than targeting specific risky sectors or types of lending that might be driving the build-up of imbalances.12
  • Interaction with Other Buffers: Some argue that large banks already hold substantial capital buffers through other regulations, such as the capital conservation buffer, stress tests, and global systemically important bank (G-SIB) surcharges, making the Accelerated Systemic Cushion potentially redundant or overly burdensome.11

Accelerated Systemic Cushion vs. Dynamic Provisioning

The Accelerated Systemic Cushion and dynamic provisioning are both macroprudential tools designed to mitigate procyclicality in the financial system, but they operate differently. The Accelerated Systemic Cushion is a capital requirement that mandates banks to hold more Common Equity Tier 1 capital during periods of credit expansion to absorb future losses. It directly impacts a bank's capital base.

In contrast, dynamic provisioning involves building up loan loss provisions during good economic times, even if there are no immediate signs of credit deterioration. These provisions are then drawn down during economic downturns to absorb unexpected loan losses, thus smoothing the impact of the credit cycle on bank profitability and lending. While both aim to create a financial buffer, the Accelerated Systemic Cushion directly affects capital adequacy ratios, whereas dynamic provisioning focuses on the recognition and reserving for potential future credit losses within a bank's loan portfolio.

FAQs

Q: What is the main objective of an Accelerated Systemic Cushion?
A: The main objective of an Accelerated Systemic Cushion is to protect the banking sector from systemic risk by requiring banks to build up a capital buffer during periods of strong credit growth, which can then be used to absorb losses during economic downturns, thereby ensuring the continued supply of credit.9, 10

Q: Who sets the level of the Accelerated Systemic Cushion?
A: The level of the Accelerated Systemic Cushion is set by national financial regulatory authorities, such as central banks or banking supervisors, based on their assessment of domestic macro-financial conditions and systemic risks.8 In the United States, the Federal Reserve Board is responsible for setting the Countercyclical Capital Buffer.7

Q: How does the Accelerated Systemic Cushion help prevent financial crises?
A: By forcing banks to accumulate more capital when risks are building in the financial system (e.g., during periods of rapid credit growth), the Accelerated Systemic Cushion provides a larger cushion to absorb losses if those risks materialize. This increased resilience helps prevent bank failures and severe disruptions to credit markets during a financial crisis.5, 6 It helps mitigate the procyclicality of the financial system.

Q: Is the Accelerated Systemic Cushion always active?
A: No, the Accelerated Systemic Cushion is a dynamic tool. Its rate can be adjusted by regulators based on economic conditions. For instance, the Federal Reserve has maintained its Countercyclical Capital Buffer at 0% for extended periods, indicating that it did not perceive an elevated risk requiring the buffer to be activated at higher levels.3, 4

Q: How does the Accelerated Systemic Cushion relate to Basel III?
A: The Accelerated Systemic Cushion (or Countercyclical Capital Buffer) is a key component of the Basel III international regulatory framework. Basel III introduced this buffer as a measure to strengthen global banking regulations and address systemic risks that emerged during the global financial crisis.1, 2