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© 2022 International Monetary Fund
WP/22/21
IMF Working Paper
Monetary and Capital Markets Department
Usability of Bank Capital Buffers: The Role of Market Expectations
Prepared by Jose Abad and Antonio Garcia Pascual
Authorized for distribution by Ranjit Singh
January 2022
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
ABSTRACT: Following the COVID shock, supervisors encouraged banks to use capital buffers to support the recovery. However, banks have been reluctant to do so. Provided the market expects a bank to rebuild its buffers, any draw-down will open up a capital shortfall that will weigh on its share price. Therefore, a bank will only decide to use its buffers if the value creation from a larger loan book offsets the costs associated with a capital shortfall. Using market expectations, we calibrate a framework for assessing the usability of buffers. Our results suggest that the cases in which the use of buffers make economic sense are rare in practice.
| JEL Classification Numbers: | G20, G21.G28 |
| Keywords: | Capital Buffers, Basel III, Capital Regulation, Financial Institutions, Macropru |
| Author’s E-Mail Address: | jabad@imf.org, agarciapascual@imf.org |
| JEL Classification Numbers: | G20, G21.G28 |
| Keywords: | Capital Buffers, Basel III, Capital Regulation, Financial Institutions, Macropru |
| Author’s E-Mail Address: | jabad@imf.org, agarciapascual@imf.org |
Title Page
WORKING PAPERS
Usability of Bank Capital Buffers: The Role of Market Expectations
Prepared by Jose Abad and Antonio Garcia Pascual1
Contents
Introduction
Capital Buffers During the COVID Crisis
Capital Buffers: A Framework to Assess Usability
Rebuilding a Bank’s Capital Position: The Role of Expectations
Bank-Level Data: Market Expectations and Bank-Own Targets
Analytical Framework
Discussion of Our Results
Robustness Checks and Discussion
Policy Proposals
Enhanced Countercyclical Capital Buffer, ECCyB
A Public Guarantee Scheme
Combining the ECCyB and Public Guarantees
When Less Is More
Other Complementary Policies to Be Considered
Conclusions
References
Figures
1. CET1 Ratios, Market Capitalization Weighted Averages
2. Subordinated Debt Prices
3. Subordinated Debt Prices
4. Key Financial Indicators
5. Management Buffers
6. Maximum Distributable Amount (MDA) Threshold
7. Estimated Years to Rebuild 2.5 Percent Buffer Draw-Down
8. 2019 NPL Ratios, Pre COVID-19
9. Evolution of a Bank’s Fair Value Post Buffer Usage
10. Number of Years to Rebuild Buffer—Sensitivity to Key Variables
11. Number of Years to Reach Required Fair Value—Sensitivity to Key Variables
12. Projected Capital and Value Shortfall for Euro Area Banks
13. RWA Relief
14. Value Shortfall
15. RWA Relief
Tables
1. Bank Capital Generation & Valuation Models: Median First-Quartile Bank
2. Step 4—Valuation (Multi-Year)
3. Analysis Results Where Buffer Usage is 2.5 Percent of Market Capitalization Weighted Averages
4. Analysis Results Where Buffer Usage is 2.5 Percent of Market Capitalization Weighted Averages
5. Sensitivity Analysis
6. Capital Buffer Usability: Success Rates, Overall and Per Hurdle, Across Different Scenarios and Policy Options
Annex
Bank Capital Structure and Implications for Buffer Usability: A Primer
We thank Tobias Adrian, Rachid Awad, Jose Berrospide, Jorge Canales, Paavo Miettinen, Fabio Natalucci, Luc Riedweg, Ranjit Singh, and Jan Strasky for their helpful comments and discussions. We also thank Deepali Gautam for her outstanding research assistance. A preliminary and much shorter version of this paper was published as part of Chapter 1 of the GFSR, April 2021 (IMF, 2021, pp. 22–26).