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A Profit-to-Provisioning Approach to Setting the Countercyclical Capital Buffer: The Czech Example

Lukas Pfeifer and Martin Hodula

Working Papers from Czech National Bank

Abstract: Over the last few years, national macroprudential authorities have developed different strategies for setting the countercyclical capital buffer (CCyB) rate in the banking sector. The existing approaches are based on various indicators used to identify the current phase of the financial cycle. However, to our knowledge, there is no approach that directly takes into consideration banks' prudential behavior over the financial cycle as well as cyclical risks in the banking sector. In this paper, we propose a new profit-to-provisioning approach that can be used in the macroprudential decision-making process. We construct a new set of indicators that largely capture the risk of cyclicality of profit and loan loss provisions. We argue that banks should conserve a portion of the cyclically overestimated profit (non-materialized expected loss) in their capital during a financial boom. We evaluate the performance of our newly proposed indicators using two econometric exercises. Overall, they exhibit good statistical properties, are relevant to the CCyB decision-making process, and may contribute to a more precise assessment of both systemic risk accumulation and risk materialization. We believe that the relevance of the profit-to-provisioning approach and the related set of newly proposed indicators increases under IFRS 9.

Keywords: Banking prudence indicators; countercyclical capital buffer; financial stability; macroprudential policy; profit-to-provisioning approach (search for similar items in EconPapers)
JEL-codes: E58 G21 G28 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-rmg
Date: 2018-05
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