UK: FPC's Incoming Countercyclical Capital Buffer | A Wider Impact Than First Thought

Last Updated: 7 December 2015
Article by Ian Kelly

Most Read Contributor in UK, August 2017

The Financial Policy Committee (FPC) of the Bank of England has confirmed that it plans to activate the Countercyclical Capital Buffer (CCyB) in the near future, perhaps as early as March 2016. The FPC announced the move in its Financial Stability Report published on 1 December 2015.

The introduction of the CCyB may come as something of a surprise for UK banks. Only three other jurisdictions in the world (Norway, Sweden and Hong Kong) have already applied this measure. This also makes the UK by far the largest financial centre to introduce a CCyB requirement.

As its name suggests, the CCyB is designed to require banks to set aside capital in prosperous trading periods which they can later use to absorb losses in difficult conditions. The FPC's report suggests it is aiming for a 1% buffer during the 'post-crisis' period, which would be phased in in 0.25% increments. It would then relax the buffer if economic conditions deteriorate, allowing banks to absorb losses without having to raise new capital. It will use indicators such as excessive leverage or credit growth to guide its ongoing decisions on whether a CCyB is necessary.

The FPC can target the CCyB at particular business lines (such as mortgage lending) and/or particular sub-sectors within the financial sector where they perceive risks to be increasing. The report does not state which sub-sectors or activities they will target, but the Bank's recent public statements about the housing and retail lending markets suggest that these will be their areas of focus.

Banks were already bracing themselves for the phased introduction of the Capital Conservation Buffer (CCoB) and the new PRA Buffer from 1 January 2016. But the introduction of the CCyB will have a more wide ranging impact than those measures:

  • Capital requirements: Technically, the CCyB is an additional requirement, separate from any existing buffers. Unlike the CCoB, which may be covered by capital already allocated to meet a Capital Planning Buffer, a CCyB requirement represents an additional capital charge. In practice, however, the Governor, Mark Carney, has stated that the Bank does not intend to raise capital requirements, and therefore any new CCyB will merely replace current forward looking components of banks' Pillar 2 capital requirements.
  • Leverage ratio requirements: As the FPC's new UK leverage ratio requirement is linked to any associated CCyB requirement, the introduction of the CCyB will drive up the leverage ratio requirement also. The leverage requirement add-on is calibrated as 35% of any CCyB requirement in effect. So if an asset or business line attracts a new 1% CCyB capital charge the leverage ratio requirement associated with it will increase by 0.35%.
  • Credit risk measurement: Banks' internal credit risk calculations will need to be updated to reflect the increased capital charge of lending. This is likely to drive cost and pricing changes for certain business lines and lending categories. In some cases banks may find themselves considering if they are allocating their capital to business lines in the most optimal way possible.
  • Pillar 3: A new CCyB disclosure template must be included in all Pillar 3 disclosures related to financial years ending on or after 01 January 2016 for all firms subject to a CCyB requirement.
  • COREP: The COREP credit risk forms contain fields that pick up data on capital requirements arising from a CCyB charge. Banks will need to update their data systems to accurately reflect which exposures are subject to the CCyB. This will involve careful monitoring of which jurisdictions and business lines its exposures are in.

As the CCyB applies to exposures in the jurisdictions which have introduced a CCyB, rather than simply to the banks in those jurisdictions, its introduction will also affect banks across Europe and further afield that have exposures in the UK. Similarly, UK banks whose exposures are mainly in the UK will face a proportionally greater cost impact than those UK banks that have that have a relatively higher proportion of their exposures outside the UK. Banks and building societies that have more a UK focused business model than some of their more internationally active peers will undoubtedly regard this imbalance as unfair.

The CCyB requirement and many of the associated consequences will also apply to FCA-regulated IFPRU Full Scope and Limited Activity investment firms that are too large to benefit from the 'SME exemption' in IFPRU and are therefore required to implement the CRD IV buffer requirements. This is a further example of the Bank of England's power to raise capital requirements for firms that it does not directly regulate, both in the UK and overseas.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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