Instruments to contain the risks of excessive credit growthPrint
Debt cap rules (Loan-to-value ratio and debt-to-income ratio)
Limits are set on the value of the loan available to retail borrowers in proportion to the underlying collateral and on the debt service costs in proportion to households’ disposable income.
The impact mechanism of the regulation is twofold. On the one hand, properly calibrated limits can restrain excessive credit outflows and hence, reduce the probability and magnitude of the build-up of cyclical risks. Consequently, they can effectively supplement the countercyclical capital buffer: indeed, in the credit market capital buffers exert their effects on the supply side, while the effects of the debt cap rules will be perceived on the demand side. In addition, the instrument also mitigates the risk of default directly by countering the occurrence of excessive indebtedness.
As its effects manifest themselves at the level of individual loan contracts, the instrument is a reliable vehicle of the regulatory objective.
Countercyclical capital buffer
Additional capital requirement set by the regulatory authority when warranted by excessive credit growth, to be reduced or released in times of financial stress.
On the one hand, the additional capital can be used to protect the banking system against losses. This increases the resilience of the banking sector and allows for “soft landing” in the event of a crisis, preventing its escalation. Secondly, the purpose of the instrument is to mitigate the fluctuations of the financial cycle. The additional capital requirement increases the cost of credit by increasing the ratio of capital – a more expensive source of funding – among banks’ liabilities. This may restrain credit supply and may ultimately lead to a decline in lending activity, a desirable outcome during periods of excessive credit growth. Similarly, in case of a credit crunch during periods of financial stress, a release of the buffer will have the opposite effect and stimulate lending activity. The MNB revises the countercyclical buffer rate quarterly.
Defining risk weights for exposures secured by real
estate collateral and defining minimum average loss given default (LGD)
Setting risk weights to address asset price bubbles in the real estate sector and defining minimum average loss given default (LGD) values for exposures to households secured by real estate collateral.
Policy instruments applicable to real estate exposures consist of increased sectoral capital requirements, primarily affecting the shock-absorbing capacity of financial institutions. In addition, due to their sector-targeted focus, they may serve as an efficient tool in the prevention of excessive credit outflows and asset price bubbles. Capital requirements can be reduced by lowering the proportion of real estate exposures, or offset by higher interest rate spreads. In both cases, depending on the intensity of the growth in credit outflows, the instruments may exert a downward effect on credit outflows. During crisis periods the requirements can be eased and the thus released capital may facilitate the maintenance of lending activity. In summary, this instrument essentially offers a solution for managing cyclical risks while being less suitable for addressing the structural dimension of real estate exposures due to the simultaneous targeting of such exposures.