Counter-Cyclical Capital Buffer

• 09 Jun 2020

• Recently, to manage the economic situation, which is hampered by COVID-19, governments and central banks world over are deploying unusual weapons aside from reductions in the Cash Reserve Ratio (CRR) and repo rates.
• The Bank of England mentioned one such unusual tool, announcing a cut in the counter-cyclical capital buffer (CCCB) to 0 per cent, from 1 per cent currently. On April 2, the financial regulatory authority of Germany also followed suit and cut the CCCB to 0 per cent from 0.25 per cent. The RBI, however, has decided that it is not necessary to activate the CCCB at this point in time.
• 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.
• However, 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.