Response to the European Commission’s consultation on countercyclical capital buffer
Norges Bank and Finanstilsynet's letter of 19 November 2010 to DG Internal Market and Services, Banking and Financial, Conglomerates Unit, European Commission.
Norges Bank and Finanstilsynet support establishing mechanisms to ensure that banks build up countercyclical capital buffers. We expressed our views on the Basel Committee’s proposal for a countercyclical capital buffer framework in a letter of 10 September to the Basel Committee. (1) In this response to the European Commission, Norges Bank and Finanstilsynet comment on questions posed in the consultation document. In summary our position is that:
i) The countercyclical buffer requirements should be set by the authorities in the jurisdiction where the borrower is located, as proposed by the Basel Committee.
ii) The countercyclical buffer should consist of common equity only.
iii) The countercyclical buffer framework should be implemented as soon as possible.
Norges Bank and Finanstilsynet generally support a strengthening of host supervisory authority powers in EU regulation, and thus strongly prefer the approach to determining the bank-specific buffers proposed by the Basel Committee. Under the Basel approach the countercyclical capital buffer minimum requirement is set by national authorities for all lending to borrowers located in their jurisdiction, regardless of the nationality or business organisation (subsidiary, foreign branch or direct cross-border lending) of the lender.
The European Commission presents two possible alternative approaches. In alternative A, countercyclical buffer requirements are decided by the home authorities of the lender, rather than by the authority in the jurisdiction of the borrower.
In alternative B, the countercyclical capital buffer requirement in a jurisdiction applies to all bank lending that is granted from the jurisdiction, irrespective of where the borrower is located.
Norges Bank and Finanstilsynet emphasise that of these three suggestions only the Basel approach will contribute to a levelling of the playing field between national and foreign banks lending to borrowers in the same country.
Alternative A leaves the home supervisor of a bank with branches in other EEA countries an opportunity to set lower individual buffers than is set by host authorities, if the home supervisors believes that those branches do not contribute to excessive credit growth in the host jurisdiction. This opportunity risks blurring the distinction between individual pillar 2 issues and macroprudential issues. Norges Bank and Finanstilsynet maintain that evaluation of the solvency of individual institutions should be assigned to the supervisory process under pillar 2, leaving the countercyclical buffer to target macroprudential risk specifically.
Under alternative A Norges Bank and Finanstilsynet are not convinced that EBA guidance and settlement can effectively mitigate the risk that buffers set by home supervisors inadequately reflect macroprudential risk in the host economy. Discretion of home supervisors may also result in the host authorities being reluctant to put the countercyclical buffer into effect, due to the risk of competitive bias resulting from home supervisors exercising their discretion.
Moreover, in our view, macroprudential risks in the real economy primarily concern the location of borrowers, and to a lesser degree the location of lenders. Under alternative A and B of the Commission, buffer decisions made by national authorities do not necessarily apply to every credit to local borrowers. Consequently, buffer decisions by national authorities may not have full effect on the macroprudential risks in the jurisdiction.
Norges Bank and Finanstilsynet believe the Basel approach will lead to less regulatory arbitrage than alternative A and B of the Commission. Alternative A and B could lead to a race to the bottom among national authorities, in an attempt to attract establishment of internationally active banks in their jurisdiction. The Basel approach seems less prone to such a race as buffer decisions of national authorities only are applicable for lending to counterparties in their own jurisdiction.
Norges Bank and Finanstilsynet support applying the countercyclical buffer requirement at solo, sub-consolidated and consolidated basis.
In principle we think this buffer should be held at the entity which is directly exposed to the system-wide risk associated with the credit cycle. Accordingly, supervisors should be entitled to require that buffer capital is held on a solo basis.
Norges Bank and Finanstilsynet would prefer that the ceiling for the countercyclical buffer is set higher than 2.5%. A higher buffer would often be required if the dampening of credit growth is one of the objectives. The very existence of a higher buffer option might also have a dampening effect. The social cost of giving regulators that option should be low, given that the criteria for imposing buffer requirements are well communicated and understood by the financial institutions.
For Norges Bank and Finanstilsynet it is essential that decisions on the countercyclical buffer requirements are transparent, and explained and communicated to the market. We believe the European Systemic Risk Board could promote these aims.
Under the Basel approach host countries must rely on home country authorities to enforce the buffer decisions of host countries for foreign branches. Norges Bank and Finanstilsynet suggest that the supervisory colleges and the European Banking Authority are given roles in securing this cooperation.
Norges Bank and Finanstilsynet urge that only common equity should be used to meet the countercyclical buffer requirements. A capital buffer should have full loss absorbency. We believe contingent convertible debt instruments should not be included in the countercyclical buffer before more experience with such instruments has been gained.
Question 9 and 10
Norges Bank and Finanstilsynet generally support that the countercyclical buffer is implemented with as few exemptions as possible in order to minimise the scope for regulatory arbitrage.
Norges Bank and Finanstilsynet recommend that the countercyclical buffer framework is implemented as soon as possible. As the countercyclical buffer framework inherently takes the economic cycle into account, phase-in arrangements are needed to a lesser extent than for other parts of the new Basel regulatory framework (“Basel III”). At worst, an extended phase-in of Basel III could contribute to excessive credit growth in EEA countries that emerge from this recession earlier than others. Authorities in a jurisdiction with excessive credit growth can of course require higher capital buffers for locally incorporated banks. Without the Basel approach to countercyclical buffers in place, however, national authorities cannot impose similar requirements on foreign banks that lend to borrowers in their jurisdiction.
Deputy Director General
Copy: The Norwegian Ministry of Finance
(1) Response to the Basel Committee's consultative document on countercyclical capital buffer. Letter of 10 September 2010