How usable are capital buffers?

On 20 September 2023, the ECB released an interesting Occasional Paper entitled „How usable are capital buffers? An empirical analysis of the interaction between capital buffers and the leverage ratio since 2016″. This paper investigates the use of capital buffers by banks in the euro area, taking into account the overlapping requirements of the risk-based capital framework and the leverage ratio capital framework from 2016 to 2022.
The analysis in this paper quantifies the usability of capital buffers across different jurisdictions and bank types, identifies the key factors influencing buffer usability, and assesses the impact of various policy measures using an extended time series. The findings suggest that while both risk-based and leverage frameworks enhance banking system resilience and financial stability, their simultaneous application can create interactions that affect capital buffer functionality. Notably, the study examines the extent to which banks could have utilized regulatory capital buffers without violating current leverage ratio requirements, revealing partial constraints on buffer usability, especially for G-SIIs that rely on internal modeling approaches for risk-based capital requirements.
The research also demonstrates the fluctuation in banks‘ ability to use capital buffers over time, with an increase observed before 2019 and a decrease following the onset of the COVID-19 pandemic. Moreover, the study reveals a critical range of RWDs between 25% and 50% where buffer usability is limited and highly sensitive to RWD changes The paper explores counterfactual scenarios, showing that positive neutral countercyclical capital buffers, leverage ratio buffers, and the full implementation of Basel III standards would enhance buffer usability, especially for G-SIIs.
Capital buffers, designed to absorb unexpected losses and bolster financial stability, have evolved in response to lessons learned from the global financial crisis. However, the interaction of these buffers with parallel regulatory requirements, including the risk-weighted and leverage ratio frameworks, presents challenges and may limit buffer usability. In particular, banks must simultaneously comply with these requirements, and the analysis focuses on overlaps between macroprudential capital buffers and the leverage ratio requirement.
Buffer usability is a complex phenomenon influenced by both a bank’s ability and willingness to use buffers. While this paper primarily addresses banks‘ ability to utilize buffers without breaching overlapping requirements, it does not delve into banks‘ willingness to do so. The research contributes to the understanding of buffer usability in the context of the leverage ratio and offers insights into its evolution, heterogeneity across countries, and the impact of policy measures.
Ongoing monitoring and policy adjustments are deemed necessary to enhance buffer usability while maintaining the integrity of leverage requirements. Additionally, future research should explore the implications of the MREL on buffer usability and the macroprudential framework.