The implementation of the Basel III Countercyclical Capital Buffer in Portugal

Abstract

Basel II capital requirements are risk sensitive because they rely on the credit quality of borrowers, which means that in a downturn of the business cycle, when capital might be needed to absorb losses, capital requirements are also expected to be higher. This procyclicality may lead to excessive risk-taking during good times and to a credit crunch during bad times, amplifying the business cycle effects. Several approaches were proposed to address this problem. The new Basel III framework directly addresses this issue, mainly through the implementation of the countercyclical capital buffer. This buffer aims to protect the banking system from periods of excessive credit growth, ensuring that the financial sector, as a whole, has enough capital to maintain the flow of credit into real economy in stress periods and that capital requirements do not constraint credit supply. The objective of this thesis is to discuss the implementation in Portugal of the Basel III countercyclical capital buffer framework. The analysis was organized in two main parts, answering two different questions. First, the historical performance of the common guide Credit-to-GDP gap, proposed by the Basel Committee on Banking Supervision (BCBS) to signal the built up of the countercyclical capital buffer, was tested. The results showed that the guide can signal the build up of the buffer complying with the objectives set. However, according to the results, some alterations to the methodology proposed may need to be considered, in order to improve the calibration for the Portuguese economy. For instance, a smoothing parameter of 1 600 instead of 400 000 to compute the trend using a recursive Hodrick-Prescott filter may provide better results, while changing the lower and upper thresholds might also be necessary. The second objective was to assess if Portuguese banks would respond to an increase of capital requirements by constraining loan supply or by other means. To do so it was used an approach based on the previous work of Francis and Osborne (2012), which studied the effects of regulatory capital requirements on capital, lending and balance sheet management of UK banks. The results suggest that Portuguese banks tend to react to capital requirement increases by raising the levels of regulatory capital.

Date of Award	27 Jan 2014
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Diana Bonfim (Supervisor)