Activating the CCyB
It's complicated
The Countercyclical Capital Buffer (CCyB) is a feature of the Basel capital rules that “can be used to increase the resilience of the financial system by raising capital requirements on internationally active banking organizations when the risk of above-normal losses is elevated.”
The CCyB, which in the United States has never been set at a level above 0%, was in the news again last week after Federal Reserve Bank of Minneapolis President Neel Kashkari renewed his call for U.S. regulators to activate it.1
A full video of Kashkari’s remarks is available here.
Rather than writing a tedious post about the substance of this debate, this post offers an overview of how the CCyB works mechanically and procedurally. This likely sounds (and probably is) even more tedious than a debate over substance, but some of these details are important, and they often get skipped over in public commentary.
A caveat before starting: This post focuses on the Federal Reserve Board, which through a policy statement has offered the most complete public explanation as to how it intends to approach the CCyB.2 The Board has the authority to set the CCyB only for certain bank holding companies, savings and loan holding companies and state member banks, while the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation have the authority to set the CCyB for certain depository institutions under their supervision. In theory, then, there could be divergent approaches taken by the agencies, but that possibility is remote enough that a focus on the Board is sufficient for purposes of this post.3
One: The CCyB may be activated or increased when “systemic vulnerabilities are meaningfully above normal.”
In the preamble to its final policy statement, the Board explained the “meaningfully above normal” standard thusly:
To further clarify when the Board would expect to increase the CCyB, the Policy Statement has been modified to state that the CCyB would be increased when systemic vulnerabilities are “meaningfully above normal.” For these purposes “meaningfully above normal” would reflect an assessment by the Board that financial system vulnerabilities were above normal and were either already at, or expected to build to, levels sufficient to generate material unexpected losses in the event of an unfavorable development in financial markets or the economy.
Further, the CCyB is generally concerned only with a specific subset of systemic vulnerabilities:
The CCyB primarily is intended to address cyclical vulnerabilities, rather than structural vulnerabilities that do not vary significantly over time. Structural vulnerabilities are better addressed through targeted reforms or permanent increases in financial system resilience.
The policy statement observes that “no single indicator or fixed set of indicators can adequately capture all the vulnerabilities in the U.S. economy and financial system,” but offers a number of examples of indicators the Board will consider, “including, but not limited to, measures of relative credit and liquidity expansion or contraction, a variety of asset prices, funding spreads, credit condition surveys, indices based on credit default swap spreads, option implied volatilities, and measures of systemic risk.”
Even if these and other indicators suggest that systemic vulnerabilities are meaningfully above normal, the CCyB policy statement does not mandate that the CCyB be activated. Instead, the Board will consider “whether the CCyB is the most appropriate of the Board’s available policy instruments to address the financial system vulnerabilities” in question.
Two: The Board’s policy statement contemplates an at least annual review of the level of the CCyB, but the Board has not adhered strictly to this commitment.
In the CCyB policy statement, the Board stated that it “expect[ed] to consider at least once per year the applicable level of the U.S. CCyB,”4 although it left open the possibility of more frequent adjustments as warranted.
Since the adoption of the CCyB policy statement in 2016, the Board has taken three on-the-record votes on the level of the CCyB, voting to affirm the CCyB at zero in December 2017, March 2019 (over a dissent from then-Governor Brainard) and December 2020. There were no CCyB-related decisions announced by the Board in 2021, nor to this point have there been any in 2022.
Thus, unless votes have been taken privately and not announced publicly, the Board has not met the expectation set out in the policy statement. And because the Board has not established a regular public cadence for announcing its decisions on the level of the CCyB, it is difficult to predict when the next announcement will come.
Three: Even if activated, it could be 12 months or more before the CCyB takes effect.
In the CCyB policy statement, the Federal Reserve Board stated that it expects to “set the level of the CCyB above zero through a public notice and comment rulemaking, or through an order issued in accordance with the APA that provides each affected institution with actual notice and an opportunity for comment.”
After a final rule raising the level of the CCyB has been announced by the Board pursuant to the process described above, the capital rules provide that the increase generally becomes effective 12 months from the date of announcement. That is, if an increase is proposed in October of Year 1 and finalized in December of Year 1,5 the increase would not take effect until December of Year 2.
The capital rules include an important caveat, however. The 12 month timeline described above does not apply if “the Board establishes an earlier effective date and includes a statement articulating the reasons for the earlier effective date.”
As constraints on agency actions go, this is quite permissive. Essentially, the Board must give banking organizations a year post-final rule to come into compliance with an increased CCyB … unless the Board just decides to do something else instead. The only constraint is that the Board must explain itself when doing so.
Accordingly, based on the plain letter of the law at least, an activated CCyB could come into effect more quickly than 12 months post-final rule, and perhaps much more quickly than 12 months depending on how far the Board is inclined to push things.
In terms of the spirit of the law, however, there is a good argument that a move to bring the CCyB into effect very quickly would not be in keeping with what the regulations intended to permit. Consistent with this view, in its CCyB policy statement the Board provided a much more limited example of how it might seek to use this authority:
In order to provide banking organizations with sufficient time to adjust to any change in the CCyB, Regulation Q provides that a determination to increase the countercyclical capital buffer amount generally will be effective 12 months from the date of announcement. However, economic conditions may warrant an earlier or later effective date. For example, it may be appropriate for an increase in the countercyclical capital buffer amount to take effect 12 months from the date that the Board proposes the increase, rather than 12 months from the issuance of a final rule.
In other words, going back to the example above of a proposed rule in October of Year 1 and a final rule in December of Year 1, the Board’s hypothetical contemplates the increase taking effect October of Year 2, rather than December of Year 2.
In addition to the quote from the policy statement, perhaps notable also as evidence of regulatory intent is then-Governor Brainard’s 2019 Congressional testimony in which she called the CCyB a “simple, predictable and slow-moving tool.”
Four: If activated, the CCyB ranges from 0% to 2.5%, and there are no explicit constraints on the pace or magnitude of changes within that range.
Under the capital rules, the CCyB cannot exceed 2.5% of risk-weighted assets.
Provided that the CCyB remains in range between 0% and 2.5%, there are no explicit constraints on the magnitude of changes in the CCyB that can be made at a single point in time or on the length of time that must pass between increases. In general, the CCyB policy statement contemplates “incremental increases” if vulnerabilities are rising gradually, but the statement also acknowledges that “larger or more frequent adjustments may be necessary” depending on the circumstances.
Many times when you see calls for the CCyB to be activated, the person advocating for the move does not specify at which level they would like the CCyB to be set. Kashkari last week similarly did not explicitly propose a number, but he did at least note that in other jurisdictions where CCyBs have been activated the CCyBs are, on average, currently set around the 1% range:6
My staff tells me that by the end of next year, 18 countries across Europe will have activated their countercyclical capital buffers. It's high time that we use our tool to its full potential. And this is not trivial. It's another 1%, 1.2%, I think is the average of other countries, of risk-weighted assets. It's a meaningful amount of capital. Not enough by itself, but it's meaningful.
Not all of these comparisons are necessarily like-for-like,7 but if interested in a further look at what other jurisdictions are doing the Bank of England earlier this summer announced its intention to raise the UK CCyB to 2% effective July 20238 and included a table showing forthcoming CCyB increases in certain jurisdictions around the world.
Five: As a technical matter, the CCyB policy statement applies only to a portion of the U.S. CCyB.
Under the Board’s capital rules, a banking organization’s overall CCyB requirement is calculated as the weighted average of the CCyB requirements for the “national jurisdictions where the [firm’s] private-sector credit exposures are located.” The adopting release for the capital rules gives the following illustrated example:
The policy statement quoted throughout this post applies only to the Board’s approach to setting the portion of the U.S. CCyB requirement applicable to a firm’s private sector credit exposures in the United States.
To be clear, though, actions by foreign jurisdictions to raise the CCyB for banks in their jurisdictions do not automatically flow through to the U.S. CCyB rule. The Federal Reserve Board must affirmatively act to raise the foreign private sector credit exposures portion of the U.S. CCyB, just as it must act to raise the U.S. portion of the rule. The processes the Board is required to follow in doing so are generally equivalent:
Countercyclical capital buffer amount for foreign jurisdictions. The Board will adjust the countercyclical capital buffer amount for private sector credit exposures to reflect decisions made by foreign jurisdictions consistent with due process requirements described in [the portion of the rules applicable to the CCyB for U.S.-based exposures].
To this point, the Board has not taken any action to activate the foreign private sector credit exposures portion of the CCyB, likely because it has judged that the complications doing so would introduce are not justified by the potential benefits.
Six: If activated, the CCyB applies only to a small group of banking organizations.
Under the U.S. capital rules, the CCyB applies only to firms subject to Category I, II or III enhanced prudential standards. Setting aside the U.S. IHCs of foreign banks, this means that an increase in the CCyB would apply only to 15 U.S.-based firms: the eight U.S. G-SIBS, a custody bank that is the only current member of Category II, and the five firms (mainly superregionals) in Category III.9
The narrow scope of the CCyB’s application can be used to make arguments in either direction concerning the merits of its activation,10 but as with the rest of these points it is worth noting here because this nuance often does not come across fully in public discussions.
Kashkari and other Reserve Bank presidents, a few of which have similarly in the past called for the CCyB to be raised,* do not have a vote on this because, as with other aspects of the capital rules, this is a decision made by the Board of Governors alone, not the Federal Open Market Committee. (Incidentally, Kashkari is not a voting member of the FOMC this year in any case.)
*Nick Timiraos of the WSJ collected a number of such calls in 2018, although of course economic conditions are now different, as are some of the Reserve Bank presidents.
Unless otherwise noted, all quotes in this post come from the policy statement.
The policy statement avers that “the Board expects to make decisions about the appropriate level of the CCyB on U.S.-based credit exposures jointly with the OCC and FDIC. In addition, the Board expects that the CCyB amount for U.S.-based credit exposures would be the same for covered insured depository institutions as for covered depository institution holding companies.”
See also this 2018 speech from then-Governor Brainard: “The CCyB framework, which was finalized in September 2016, requires the Federal Reserve Board to vote at least once per year on the level of the CCyB.”
Per the policy statement, “in setting the level of the CCyB above zero through a public rulemaking, the Board generally expects that the notice and comment period would be at least 30 days.”
This is at around the 2:00 mark of the video linked to in the introduction to this post.
The CCyB does not work the same way in every jurisdiction, so you have to be careful with cross-jurisdictional comparisons. In the UK, for example, the CCyB in standard conditions is not set at zero like in the United States, but is instead set at 1 percent, with other required buffers adjusted accordingly.
It bears noting that last week the Bank of England forecasted that it is expecting the UK to enter a prolonged recession starting later this year. Whether that will affect the Bank’s plans for the CCyB hike in 2023 remains to be seen.
The Board does not need further Congressional authorization to activate the CCyB, but even so it probably makes it easier politically that community banks and smaller regionals would be spared from any CCyB increase. Regulators would be able to say, credibly, that the status quo on capital would remain unchanged for the vast majority of U.S. banks.
On the other hand, as commenters on the policy statement pointed out, the premise of the CCyB that the best way to address financial system vulnerabilities is by focusing on the regulated banking system may not always be correct.
Commenters also argued that the CCyB would not be effective in addressing many systemic vulnerabilities because it applies only to advanced approaches banking organizations, which, while significant, represent a relatively small percentage of the total provision of credit in the U.S. economy.
A commenter contended that activation of the CCyB might exacerbate risk in the financial system by shifting lending activity away from large and closely regulated commercial banks and into the shadow banking system.