Minutes of the Bank Board Meeting on financial stability issues

Present at the meeting: Aleš Michl, Eva Zamrazilová, Jan Frait, Karina Kubelková, Tomáš Holub, Jan Kubíček, Jan Procházka

The meeting opened with a presentation given by the Financial Stability Department summarising the main conclusions of Financial Stability Report - Spring 2024. The key areas covered were an assessment of the cyclical risks in the domestic economy in the current phase of the financial cycle, the identification of structural risks arising from the long-term characteristics of the Czech economy and the evolution of risks associated with the debt financing of residential property. Besides these topics, the Department presented the results of stress tests of selected segments of the financial and non-financial sector. Based on the material presented, the Bank Board comprehensively evaluated the latest financial stability developments and then discussed the countercyclical buffer rate and the introduction of a systemic risk buffer and assessed the appropriateness of the current settings of the upper limits on the LTV, DTI and DSTI ratios.

In a discussion about the overall configuration and future course of macroprudential policy, Governor Aleš Michl said he generally preferred macroprudential instruments to be on the tight side, but a compromise had to found between making the financial sector sufficiently resilient and maintaining capital buffers at a prudent level. The majority of the other board members shared this view. Given the observed decline in cyclical risks and the potential growth in some structural risks, it did not seem necessary to increase the overall capital requirements in the banking sector at present. In this regard, Deputy Governor Eva Zamrazilová emphasised that the macroprudential instrument settings should also be seen in the context of the future course of monetary policy, which was likely to be eased gradually in the period ahead. The two policies should therefore not counteract or restrict each other.

The Board went on to discuss the costs associated with the overall configuration of the macroprudential capital requirements. It was said that increasing the macroprudential buffers could imply an increase in the cost of financing for banks (Tomáš Holub). This could ultimately be reflected in growth in client loan rates and generally limit the effectiveness of bank intermediation. Against this, it was said (Deputy Governor Jan Frait) that the overall cost of financing always derives from the cost of own funds and external funds, with the capitalisation of banks generally being inversely proportional to the cost of external funds. On the one hand, therefore, higher equity implies a higher cost of own funds. On the other hand, it can improve investors' and rating agencies' perception of a bank's resilience and hence reduce the cost of debt financing. Deputy Governor Jan Frait added that the aggregate capital ratio of the domestic banking sector was now near the European average, unlike in previous years.

The countercyclical buffer (CCyB) rate

In the part of its presentation dealing with the CCyB rate, the Financial Stability Department said that the domestic economy was in an initial recovery phase close to the bottom of the financial cycle. The taking on of new risks remained subdued for now and previously assumed cyclical risks were continuing to recede from banks' balance sheets. The total accumulated cyclical risks were therefore low and were not expected to change greatly over the year ahead despite a moderate rise in lending and the switch to an expansionary phase of the financial cycle.

The board members agreed with this assessment. There was a consensus that in these conditions, the appropriate macroprudential response was to lower the CCyB rate further. A majority of the board members felt that, given the incipient turnaround in the financial cycle, this would probably be the last rate cut in the current process of easing the CCyB and the CCyB rate could be expected to be stable in the period ahead.

In a discussion of the optimal size of the current CCyB rate cut, Karina Kubelková noted that the quantitative methods used were indicating a reduction of 0.25 pp to 1.5% and in her view still provided suitable initial guidance for setting the CCyB rate. On the other hand, the opinion was expressed (Tomáš Holub, Jan Kubíček) that this instrument should already be close to the level regarded as neutral, i.e. close to or just below 1%, in the present phase of the financial cycle. This would equate to a reduction of at least 0.5 pp. In the following discussion, Deputy Governor Jan Frait said that easing the CCyB rate by this much might also send a signal in the direction of a slight recovery in credit and investment activity among non-financial corporations, although the strength of this effect should not be overestimated.

After the discussion, the Board decided to lower the CCyB rate to 1.25% with effect from 1 July 2024. All seven board members (Aleš Michl, Eva Zamrazilová, Jan Frait, Karina Kubelková, Tomáš Holub, Jan Kubíček, Jan Procházka) voted in favour of this reduction.

The systemic risk buffer (SyRB) rate

The following part of the Board's meeting was focused on assessing structural systemic risks. In the Financial Stability Department's presentation, it was said that the sensitivity of the domestic economy to adverse shocks from abroad had increased substantially in an environment of geopolitical tensions, deglobalisation and ongoing transition to a zero-emission economy. This increase was due, among other things, to the domestic economy's high foreign trade concentration, with close links to Germany, and to its production focus on a relatively small number of industries with relatively high emission intensity. Other unfavourable trends included growing cyber risk against the backdrop of the war in Ukraine and the need for technological change, with potential impacts on labour productivity. These risks are longer term in nature and could ultimately give rise to higher default rates. According to the Financial Stability Department, the systemic risk buffer (SyRB) was the most appropriate tool for increasing the banking sector's resilience to these risks, owing to their low direct link to the financial cycle.

The Board agreed that the said risks could be systemic and had the potential to foster higher default rates in the long term. Given the tail-end nature of the risks and lack of historical experience, however, the impacts were difficult to quantify exactly. In the debate, Jan Kubíček pointed to the absence of exact criteria for setting the specific SyRB rate level and for deciding when the underlying risks had receded. In this connection, however, Jan Procházka noted that despite the uncertainty and difficulties with quantification, it was clear that major structural shocks were becoming more frequent and more likely to occur in the future. Karina Kubelková agreed, pointing out that this type of risk was virtually impossible to model based on historical experience in the Czech economy and expert judgement would always have to be relied on to some extent. The results of the banking sector stress tests could offer some guide. They were indicating a need for higher releasable buffers in case a strongly adverse scenario were to materialise. In this regard, she considered it reasonable to set the SyRB rate at 1%.

Deputy Governor Eva Zamrazilová agreed that the post-Covid period had brought with it some structural changes that could amplify common sorts of shocks. However, she said that banks were well aware of these changes and were carefully assessing the relevant risks and maintaining sufficiently large voluntary buffers with regard to the ongoing changes. The conversion of voluntary buffers into mandatory ones might send a signal that the risks identified were in fact worse than market participants were expecting. Likewise, Tomáš Holub noted that macroprudential policy should react mainly where there was a danger of market failure. Given banks' current behaviour and sufficiently large voluntary buffers, however, we were not currently observing this. In this regard, therefore, the existence of structural risks should not currently lead to an increase in the total macroprudential capital requirements.

The Board then discussed the relationship between structural and cyclical risks. It was said in the discussion that macroprudential decision-making was particularly complicated in this area, because the two sorts of risks were hard to disentangle (Deputy Governor Eva Zamrazilová). This was especially true of the risks associated with high foreign trade and industry concentration, the materialisation of which would give rise to a cyclical contraction. It might therefore be more natural to cover part of these risks with the countercyclical buffer, while the introduction of the SyRB should be motivated primarily by risks of a purely structural nature, such as cyber risk and climate transition risk (Tomáš Holub).

Deputy Governor Jan Frait conceded that there was uncertainty surrounding the exact categorisation of some types of risk in practice, but described the split into cyclical and structural risks itself as useful and quite easy to communicate. Any uncertainty with quantification and classification could be dealt with by means of expert judgement, subject to the prudential principle. In the debate, he also emphasised that differentiating between the cyclical and structural elements of systemic risk was becoming standard practice in the contemporary European regulatory environment, and we should not deviate from that. He also said that the CNB had good past experience with the approach of setting new types of instrument initially at a less tight level and then reacting flexibly based on an assessment of the intensity of risks. Jan Procházka was also in favour of differentiating between the two sorts of risks and covering them with different sorts of buffers, owing to the greater flexibility and economic validity of this approach. He also noted that besides potential overlaps between the cyclical (CCyB) and structural (SyRB) macroprudential buffers, it had also been necessary to check for overlaps with the microprudential requirements applied under Pillar II. The proposed approach to the SyRB would virtually rule out such overlaps. Jan Kubíček agreed that the SyRB would increase the room for macroprudential policy manoeuvre but expressed his belief that there was no need to apply it at the moment, not least because we had already opted for a highly prudential approach in the case of the CCyB, where the main quantitative methods had originally implied a lower rate. He would regard it as more logical to apply a sectoral SyRB, as it can mitigate systemic risk in the area or sector where the regulator sees it, whereas a general SyRB cannot.

After discussing the structural risks, the Board decided to introduce the SyRB. Five board members (Aleš Michl, Jan Frait, Karina Kubelková, Tomáš Holub, Jan Procházka) voted in favour of doing so, while two board members (Eva Zamrazilová, Jan Kubíček) voted against. In the subsequent vote on the rate level, six board members (Aleš Michl, Jan Frait, Karina Kubelková, Jan Kubíček, Tomáš Holub, Jan Procházka) voted to set the rate at 0.5% with effect from 1 January 2025. One board member (Eva Zamrazilová) voted against this level.

Upper limits on credit ratios

In the final part of the meeting, the Board discussed the risks connected with the provision of consumer loans secured by residential property. In the Financial Stability Department's presentation, it was said that elevated interest rates were still suppressing lending, so the mortgage market had been recovering only slowly thus far. The overall systemic risks arising from the housing loan market remained low and were unlikely to increase significantly over the outlook, despite some growth in loans with higher risk parameters in an environment of deactivated binding upper DSTI and DTI limits.

The board members agreed with the Financial Stability Department's assessment. They concurred that the current settings of the upper limits on the ratios were still consistent with the conditions observed on the mortgage and residential property market, and the developments in recent months did not give cause to change macroprudential policy in this area. In the following debate, Karina Kubelková said that the subdued systemic risk made it possible now also to consider changing the binding LTV limits into recommended ones. This option was supported by the prudent approach taken by banks themselves to LTV and by the incomplete take-up of the statutory volume exemption. In response, Tomáš Holub said that the binding upper LTV limit acted as a safeguard against an acceleration of the mortgage cycle. Although the current situation did not warrant any change to the upper limits for the time being, he personally now saw some risk of a faster recovery on the mortgage market and related faster growth in house prices. Deputy Governor Jan Frait agreed, emphasising that in view of the incipient expansionary phase of the cycle, he no longer felt it was appropriate to ease macroprudential policy further in the area of borrower-based measures.

After the discussion, the Board decided to leave the upper limit on the LTV ratio at 80% (90% for applicants under 36 years purchasing owner-occupied housing). All seven board members (Aleš Michl, Eva Zamrazilová, Jan Frait, Karina Kubelková, Jan Holub, Jan Kubíček, Jan Procházka) voted to leave the upper limit on the LTV ratio unchanged. The Board also unanimously approved a new version of the Recommendation on the management of risks associated with the provision of consumer credit secured by residential property expanding the applicability of the Recommendation to housing loans not secured by residential property.

Author of the minutes: Miroslav Plašil, Financial Stability Department

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