FINANCIAL STABILITY
Macroprudential Policy
Introduction
The
Central Bank of Armenia pursues a macro-prudential policy in order to maintain
and enhance financial stability. In practice, macro-prudential policies involve
identification of systemic risks, such as selecting and applying
macro-prudential tools to mitigate or neutralize those risks, which will
contribute to the strengthening of financial stability.
Macro-prudential policy concept
Intermediate goals of macro-prudential
policy
The effective choice of macro-prudential
instrument(s) is based on the intermediate objectives of the macro-prudential
policy; these, in essence, describe the possible sources of systemic risk
exposure. That is, first the possible sources of risks are assessed, their
relative strength, from which the specific intermediate goal(s) of the macro-prudential
policy will be targeted and the appropriate macro-prudential tool(s) selected.
The main intermediate goals of macro-prudential policy include:
- Mitigate or prevent excessive growth
of lending or excessive leverage
- Mitigate or prevent excessive maturity
mismatch and liquidity problems
- Limit the risk of concentration
- Limit the systemic impact of
false stimuli and reduce the risk of moral hazard.
Macro-prudential tools
- Counter-cyclical capital buffer
- Capital conservation buffer
- Lending restrictions on real
estate-secured loans
- Capital requirement for systemically
important financial institutions
Counter-cyclical capital buffer
The use of a counter-cyclical
capital buffer was proposed by the Basel Committee on Bank Supervision under
Basel III. The procedure for “Setting and Calculating Thresholds above the Capital
Adequacy Ratio of Banks” approved by the Board of the Central Bank of Armenia has
been effective since April 1, 2019. The procedure establishes, among other
thresholds, the counter-cyclical threshold of capital (hereinafter counter-cyclical
capital buffer).
The counter-cyclical capital buffer
is intended to increase the ability of the financial system to withstand
financial and economic shocks and to ensure the smooth flow of financial
resources provided to the economy through lending.
The counter-cyclical capital
buffer targets the excessive (risky) growth of loans by mitigating the negative
effects it would have on the stability of financial system. To curb the excessive
growth of loans, the Central Bank raises the capital requirement when the
financial cycle is upward, creating an additional buffer. When the financial
cycle is downward, the buffer will decrease, so that financial institutions will
be able to cover losses, thereby reducing the need for large-scale lending by financial
system participants (deleveraging), and its adverse effects on financial
stability and economic growth.
The Central Bank makes decisions
on the counter-cyclical capital buffer every quarter. The deciding on the
counter-cyclical capital buffer by the Central Bank of Armenia is detailed in
the paper “General Methodology for Setting the Counter-Cyclical Capital
Threshold”.
Counter-cyclical capital buffer rate
Capital conservation buffer
The capital conservation buffer assumes (is designed in such a way) that the financial institution must accumulate the required amount of capital over its activity, which can be used to cover possible losses in a stressful situation.
The procedure for “Setting and
Calculating Thresholds above the Capital Adequacy Ratio of Banks” (CBA Board
resolution No: 16-N, dated February 4, 2019) defines the required rates for a capital
conservation threshold (buffer) and the timetable, as follows:
- From January 1, 2020 to December
31, 2020 (inclusive) - at the rate of 0.5%
- From January 1, 2021 to December
31, 2021 (inclusive) - at the rate of 1%
- From January 1, 2022 to December
31, 2022 (inclusive) - at the rate of 1.5%,
- From January 1, 2023 to December
31, 2023 (inclusive) - at the rate of 2%,
- Since January 1, 2024 - at the
rate of 2.5%.
Lending restrictions on real estate-secured loans
Unlike other macro-prudential tools
that assume a capital related requirement, this group of macro-prudential tools
assumes a credit related requirement/offer to the borrower for a change in lending
terms. In international practice, the maximum limits on loan-to-debt, debt to
income and debt service to income ratios are widely used. Central banks use
such types of macro-prudential tools to address, in particular, the imbalances
in mortgage loans and real estate market, and the resultant accumulation of
systemic risks.
Capital requirement for systemically important banks
The additional capital
requirement for systemically important banks is intended to reduce the
likelihood of systemic risk, which may arise from possible destabilization of
these banks, by enhancing the resilience of such banks and their ability to
withstand various types of shocks. The destabilization of systemically
important banks can impair an efficient functioning of the banking system,
which in turn can negatively affect the financial system and real economy on
the whole.
According to the Basel Committee,
in order to determine if a bank is systemically important, one should take into
account the possible amount of damage (impact) the bank would cause to the
financial system, once turned insolvent, rather than the probability that the
bank may become insolvent.
Each year, the Central Bank of
Armenia approves, under a relevant governor decision, the list of banks that
are considered to be of systemic importance.
Determination of systemically important
banks is based on the following group of features: size, affiliation,
interchangeability, complexity and other specificities peculiar to the Armenian
financial system (Guide for Determination of Systemically Important Banks).
The procedure for “Setting and
Calculating Thresholds above the Capital Adequacy Ratio of Banks” (CBA Board
resolution No: 16-N, dated February 4, 2019) defines the rates for systemically
important banks threshold and the timetable, as follows:
- From January 1, 2020 to December
31, 2021 (inclusive) - at the rate of 0.5%
- From January 1, 2022 to December
31, 2022 (inclusive) - at the rate of 1%
- Since January 1, 2023 - at the
rate of 1.5%.