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

29 Pages Posted: 5 Nov 2020

See all articles by Lukáš Pfeifer

Lukáš Pfeifer

Czech National Bank (CNB); University of Economics Prague

Martin Hodula

Czech National Bank (CNB); VSB - Technical University of Ostrava

Date Written: August, 2018

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

JEL Classification: E58, G21, G28

Suggested Citation

Pfeifer, Lukáš and Hodula, Martin, A Profit-to-Provisioning Approach to Setting the Countercyclical Capital Buffer: The Czech Example (August, 2018). ESRB: Working Paper Series No. 2018/82, Available at SSRN: https://ssrn.com/abstract=3723430 or http://dx.doi.org/10.2139/ssrn.3723430

Lukáš Pfeifer (Contact Author)

Czech National Bank (CNB) ( email )

Na Prikope 28
CZ-11503 Praha 1
Czech Republic

University of Economics Prague ( email )

Czech Republic

Martin Hodula

Czech National Bank (CNB) ( email )

Na Prikope 28
CZ-11503 Praha 1
Czech Republic

VSB - Technical University of Ostrava ( email )

17. listopadu 2172/15
Ostrava, 708 00
Czech Republic

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