How do different bank capital requirements function in bad times?
- Henrik Andersen, Charlotte Høeg Haugen, Jama Johnsen, Lars-Tore Turtveit and Bent Vale
- Staff Memo
Use of capital buffers can dampen the risk that banks amplify downturns. But other requirements could prevent banks from using the buffers countercyclically, especially if the consequences of breaching other requirements are more serious than breaching buffer requirements. In this Staff Memo we analyse how the buffer requirements function in bad times when banks must also satisfy the leverage ratio (LR) requirement and the minimum requirement for own funds and eligible liabilities (MREL). The results show that the portion of MREL that the largest Norwegian banks may have to use the most Common Equity Tier 1 (CET1) capital to satisfy is risk-based subordinated MREL calculated using the prudential formula. According to our calculations, banks must use a substantial share of their buffer capital to satisfy this requirement, at least if banks’ non-preferred debt issuance is small. This implies that a number of banks could breach only portions of the buffer requirements without breaching MREL. The analysis also shows that this overlap between the buffer requirements and the prudential formula could increase in bad times. If the countercyclical capital buffer (CCyB) requirement and other buffer requirements are reduced, risk-based subordinated MREL will be reduced accordingly, so that the buffers function as intended. If banks’ non-preferred debt issuance is substantial, they could also dip into a larger share of their capital buffers without breaching MREL.
Staff Memos present reports and documentation written by staff members and affiliates of Norges Bank, the central bank of Norway. Views and conclusions expressed in Staff Memos should not be taken to represent the views of Norges Bank.
ISSN 1504-2596 (online)