Bank capital buffers may get rethink after Covid stress test

4 min read
Steve Slater

Global and national banking regulators are ready to take a fresh look at how capital buffers for banks are set and used so they can be a better tool to help economic recovery during times of stress, top regulators said.

After the coronavirus pandemic erupted in March banks were given a green light to use "rainy day" buffers, but most appear reluctant and wary of using them. Banks are worried investors, ratings agencies or others may react badly, even if supervisors are happy.

"It's very clear that the system of buffers as we have it now needs some further work, probably some further conceptual work, and at least some further refinement and calibration to make the buffers actually available at a time of stress," said Randal Quarles, head of supervision at the US Federal Reserve and chair of the Financial Stability Board.

"That's definitely a topic that needs to be on the agenda for regulators both domestically and globally," Quarles said on Thursday at the Institute of International Finance annual meeting, held virtually this year.

"It's very clear, that notwithstanding strong urging from their supervisors to use their buffers, banks were reluctant to."

The US Federal Reserve, European Central Bank, Bank of England and others have relaxed capital requirements since March, including for countercyclical buffers that were added to minimum levels. The buffers were set up after the 2008-09 financial crisis, and designed so banks would increase capital in good times and draw them down in bad times, while staying above minimum capital requirements.

The sudden Covid crisis was seen as a textbook time to use the buffers. But banks have healthy capital levels, however, which has also limited the need to use buffers. Many expect the true test will come in 2021 as losses from bad loans mount.

Citigroup chairman John Dugan said there had not been enough demand from clients for Citi to eat into its buffers, and the same was true for peers. But he said there was a worry banks will be reluctant to use the buffers if the situation deteriorates, due to the reaction of ratings agencies or others.

"I don't think we've fairly run the experiment, because we haven't got to that tipping point. But I do believe there are constraints there that will make it difficult for firms to use buffers and will make them not want to use them unless they really need to," Dugan said at the IIF event.

Quarles acknowledged the reason why banks may want to avoid using the buffers too.

"Some of that reluctance can be attributed to uncertainty as to whether we (regulators) really meant it when we said we want you to use your buffers," he said.

"Some of it was due to uncertainty as to how market participants would take using a buffer, even though it's clearly designed to be a buffer and capital was clearly adequate."

The Basel Committee on Banking Supervision (BCBS), the global standard-setter for bank rules, is also concerned buffers may not serve their purpose. It was looking at the issue before the Covid crisis, said Carolyn Rogers, secretary general of the BCBS.

"We had a sense that despite our intention that the buffers would be drawn down in stressed times, that they were being treated by the market and in some cases by the banks themselves ... as a de facto minimum. So this was something we were worried about," Rogers said.

But she said their use had not been properly tested, due to well-capitalised banks and because the Covid crisis had not prompted deleveraging or lending constraints that could cause a problem.

The complexity of capital rules means the challenge may be a communication issue rather than a structural problem, she said.

"I want to see the evidence [that buffers don't work] before we start the redesigning process," she said.