Basel Committee on Banking Supervision

This chapter outlines the operation of the capital conservation buffer, which is designed to ensure that banks build up capital buffers outside periods of stress which can be drawn down as losses are incurred. The requirement is based on simple capital conservation rules designed to avoid breaches of minimum capital requirements.

A capital conservation buffer of 2.5%, comprised of Common Equity Tier 1 (CET1), is established above the regulatory minimum capital requirement.¹ Capital distribution constraints will be imposed on a bank when capital levels fall within this range. Banks will be able to conduct business as normal when their capital levels fall into the conservation range as they experience losses. The constraints imposed only relate to distributions, not the operation of the bank.

The distribution constraints imposed on banks when their capital levels fall into the range increase as the banks’ capital levels approach the minimum requirements. By design, the constraints imposed on banks with capital levels at the top of the range would be minimal. This reflects an expectation that banks’ capital levels will from time to time fall into this range. The Basel Committee does not wish to impose constraints for entering the range that would be so restrictive as to result in the range being viewed as establishing a new minimum capital requirement.

The table below shows the minimum capital conservation ratios a bank must meet at various levels of CET1 capital ratios. The applicable conservation standards must be recalculated at each distribution date. For example, a bank with a CET1 capital ratio in the range of 5.125% to 5.75% is required to conserve 80% of its earnings in the subsequent payment period (ie pay out no more than 20% in terms of dividends, share buybacks and discretionary bonus payments). If the bank wants to make payments in excess of the constraints imposed by this regime, it would have the option of raising capital in the private sector equal to the amount above the constraint which it wishes to distribute. This would be discussed with the bank’s supervisor as part of the capital planning process. The CET1 ratio includes amounts used to meet the 4.5% minimum CET1 requirement, but excludes any additional CET1 needed to meet the 6% Tier 1 and 8% Total Capital requirements, and also excludes any CET1 needed to meet the total loss-absorbing capacity (TLAC) requirement. For example, a bank with 8% CET1 and no Additional Tier 1 or Tier 2 capital, that has 10% of non-regulatory-capital TLAC instruments, would meet its minimum risk-based capital and risk-based TLAC requirements, but would have a zero conservation buffer and therefore be subject to the 100% constraint on capital distributions.

Set out below are a number of other key aspects of the requirements:

1. Elements subject to the restriction on distributions: Items considered to be distributions include dividends and share buybacks, discretionary payments on other Tier 1 capital instruments and discretionary bonus payments to staff. Payments that do not result in a depletion of CET1, which may for example include certain scrip dividends, are not considered distributions. The distribution restrictions do not apply to dividends which satisfy all three of the following conditions:
   1. the dividends cannot legally be cancelled by the bank;
   2. the dividends have already been removed from CET1; and
   3. the dividends were declared in line with the applicable capital conservation standards (as set out in RBC30.4) at the time of declaration.
2. Definition of earnings: Earnings are defined as distributable profits calculated prior to the deduction of elements subject to the restriction on distributions. Earnings are calculated after the tax which would have been reported had none of the distributable items been paid. As such, any tax impact of making such distributions are reversed out. Where a bank does not have positive earnings and has a CET1 ratio less than 7% (or higher if the capital conservation buffer has been expanded by other buffers), it would be restricted from making positive net distributions.
3. Solo or consolidated application: The framework should be applied at the consolidated level, ie restrictions would be imposed on distributions out of the consolidated group. National supervisors would have the option of applying the regime at the solo level to conserve resources in specific parts of the group.
4. Additional supervisory discretion: Although the buffer must be capable of being drawn down, banks should not choose in normal times to operate in the buffer range simply to compete with other banks and win market share. To ensure that this does not happen, supervisors have the additional discretion to impose time limits on banks operating within the buffer range on a case-by-case basis. In any case, supervisors should ensure that the capital plans of banks seek to rebuild buffers over an appropriate timeframe.

Losses incurred in the banking sector can be extremely large when a downturn is preceded by a period of excess credit growth. These losses can destabilise the banking sector and spark a vicious circle, whereby problems in the financial system can contribute to a downturn in the real economy that then feeds back on to the banking sector. These interactions highlight the particular importance of the banking sector building up additional capital defences in periods where the risks of system-wide stress are growing markedly.

The countercyclical buffer aims to ensure that banking sector capital requirements take account of the macro-financial environment in which banks operate. It will be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. This focus on excess aggregate credit growth means that jurisdictions are likely to only need to deploy the buffer on an infrequent basis. The buffer for internationally-active banks will be a weighted average of the buffers deployed across all the jurisdictions to which it has credit exposures. This means that they will likely find themselves subject to a small buffer on a more frequent basis, since credit cycles are not always highly correlated across jurisdictions.

The countercyclical buffer regime consists of the following elements:

1. National authorities will monitor credit growth and other indicators that may signal a build up of system-wide risk and make assessments of whether credit growth is excessive and is leading to the build up of system-wide risk. Based on this assessment they will put in place a countercyclical buffer requirement when circumstances warrant. This requirement will be released when system-wide risk crystallises or dissipates.
2. Internationally active banks will look at the geographic location of their private sector credit exposures and calculate their bank specific countercyclical capital buffer requirement as a weighted average of the requirements that are being applied in jurisdictions to which they have credit exposures.
3. The countercyclical buffer requirement to which a bank is subject will extend the size of the capital conservation buffer. Banks will be subject to restrictions on distributions if they do not meet the requirement.

Each Basel Committee member jurisdiction will identify an authority with the responsibility to make decisions on the size of the countercyclical capital buffer. If the relevant national authority judges a period of excess credit growth to be leading to the build up of system-wide risk, they will consider, together with any other macroprudential tools at their disposal, putting in place a countercyclical buffer requirement. This will vary between zero and 2.5% of risk weighted assets, depending on their judgement as to the extent of the build up of system-wide risk.²

The document entitled “ Guidance for national authorities operating the countercyclical capital buffer ”, sets out the principles that national authorities have agreed to follow in making buffer decisions. This document provides information that should help banks to understand and anticipate the buffer decisions made by national authorities in the jurisdictions to which they have credit exposures.

To give banks time to adjust to a buffer level, a jurisdiction will pre-announce its decision to raise the level of the countercyclical buffer by up to 12 months.³ Decisions by a jurisdiction to decrease the level of the countercyclical buffer will take effect immediately. The pre-announced buffer decisions and the actual buffers in place for all Committee member jurisdictions will be published on the Bank for International Settlements’ (BIS) website .

Banks will be subject to a countercyclical buffer that varies between zero and 2.5% to total risk weighted assets.⁴ The buffer that will apply to each bank will reflect the geographic composition of its portfolio of credit exposures. Banks must meet this buffer with CET1 or be subject to the restrictions on distributions set out in RBC30.17.

Internationally active banks will look at the geographic location of their private sector credit exposures (including non-bank financial sector exposures) and calculate their countercyclical capital buffer requirement as a weighted average of the buffers that are being applied in jurisdictions to which they have an exposure. Credit exposures in this case include all private sector credit exposures that attract a credit risk capital charge or the risk weighted equivalent trading book capital charges for specific risk, the incremental risk charge and securitisation.

The weighting applied to the buffer in place in each jurisdiction will be the bank’s total credit risk charge that relates to private sector credit exposures in that jurisdiction,⁵ divided by the bank’s total credit risk charge that relates to private sector credit exposures across all jurisdictions.

For the value-at-risk (VaR) charge for specific risk, the incremental risk charge and the comprehensive risk measurement charge, banks should work with their supervisors to develop an approach that would translate these charges into individual instrument risk weights that would then be allocated to the geographic location of the specific counterparties that make up the charge. However, it may not always be possible to break down the charges in this way due to the charges being calculated on a portfolio by portfolio basis. In such cases, the charge for the relevant portfolio should be allocated to the geographic regions of the constituents of the portfolio by calculating the proportion of the portfolio’s total exposure at default (EAD) that is due to the EAD resulting from counterparties in each geographic region.

The countercyclical buffer requirement to which a bank is subject is implemented through an extension of the capital conservation buffer described in RBC30.1 to RBC30.5.

The table below shows the minimum capital conservation ratios a bank must meet at various levels of the CET1 capital ratio.⁶ When the countercyclical capital buffer is zero in all of the regions to which a bank has private sector credit exposures, the capital levels and restrictions set out in the table are the same as those set out in RBC30.1 to RBC30.5.

For illustrative purposes, the following table sets out the conservation ratios a bank must meet at various levels of CET1 capital if the bank is subject to a 2.5% countercyclical buffer requirement.

Banks must ensure that their countercyclical buffer requirements are calculated and publically disclosed with at least the same frequency as their minimum capital requirements. The buffer should be based on the latest relevant jurisdictional countercyclical buffers that are available at the date that they calculate their minimum capital requirement.

Outside of periods of stress, banks should hold buffers of capital above the regulatory minimum. Implementation of the buffers in this chapter will help increase sector resilience going into a downturn, and provide the mechanism for rebuilding capital during the early stages of economic recovery. Retaining a greater proportion of earnings during a downturn will help ensure that capital remains available to support the ongoing business operations of banks through the period of stress.

When buffers have been drawn down, one way banks should look to rebuild them is through reducing discretionary distributions of earnings. This could include reducing dividend payments, share-backs and staff bonus payments. Banks may also choose to raise new capital from the private sector as an alternative to conserving internally generated capital. The balance between these options should be discussed with supervisors as part of the capital planning process.

Greater efforts should be made to rebuild buffers the more they have been depleted. Therefore, in the absence of raising capital in the private sector, the share of earnings retained by banks for the purpose of rebuilding their capital buffers should increase the nearer their actual capital levels are to the minimum capital requirement.

It is not acceptable for banks which have depleted their capital buffers to use future predictions of recovery as justification for maintaining generous distributions to shareholders, other capital providers and employees. These stakeholders, rather than depositors, must bear the risk that recovery will not be forthcoming. It is also not acceptable for banks which have depleted their capital buffers to try and use the distribution of capital as a way to signal their financial strength. Not only is this irresponsible from the perspective of an individual bank, putting shareholders’ interests above depositors, it may also encourage other banks to follow suit. As a consequence, banks in aggregate can end up increasing distributions at the exact point in time when they should be conserving earnings.