Counter-cyclical Capital Buffer
What is Counter-cyclical Capital Buffer?
Following Basel-III norms, central banks specify certain capital adequacy norms for banks in a country. The CCCB is a part of such norms and is calculated as a fixed percentage of a bank’s risk-weighted loan book.
How is it different from capital adequacy ratios?
- One key respect in which the CCCB differs from other forms of capital adequacy is that it works to help a bank counteract the effect of a downturn or distressed economic conditions.
- With the CCCB, banks are required to set aside a higher portion of their capital during good times when loans are growing rapidly, so that the capital can be released and used during bad times, when there’s distress in the economy.
- The CCCB is supposed to be in the form of equity capital, and if the minimum buffer requirements are breached, capital distribution constraints such as limits on dividends and share buybacks can be imposed on the bank.
Indian case –
Although the RBI had proposed the CCCB for Indian banks in 2015 as part of its Basel-III requirements, it hasn’t actually required the CCCB to be maintained, keeping the ratio at zero per cent ever since. This is based on the RBI’s review of the credit-GDP gap, the growth in GNPA, the industry outlook assessment index, interest coverage ratio and other indicators, as part of the first monetary policy of every financial year.
- Apart from acting as a buffer that can be drawn upon during distress, the CCCB also helps head off systemic risks by curbing unruly bank credit growth. Systemic risks refer to events that can, besides impacting individual banks, shake up the financial system.
- When an economy in a distress a need arises for banks to increase their credit. The CCCB ensures that central banks can direct bankers to release more credit by freeing up capital, when distress situations arise.
- In India, the RBI’s move to not to impose the CCCB on banks from 2015 has meant they don’t have any capital buffer to draw on. But not activating it now can help banks keep up the credit flow in the economy. While banks may prefer to go with the flow, tools like the CCCB come in handy for the regulator to nudge them to swim against the tide.
Source – The Hindu Business Line
QUESTION – What is counter-cyclical capital buffer? Examine its significance in the times of crisis.