Countercyclical capital buffer

The countercyclical capital buffer was introduced into international regulation for credit institutions after the financial crisis as part of a larger set of reforms to make the financial sector more robust.

The buffer shall be built in periods when risks in the financial system build up. This will typically be in periods of optimism, low risk perception, rising asset prices and lenient credit terms, such as was the case in the years leading up to the financial crisis. The goal is that the buffer is built up before risks materialise, for example, before the financial system is exposed to a negative shock. In periods of financial stress, the buffer is released and credit institutions can use the released capital to maintain adequate credit.

Countercyclical capital buffer

Purpose

The purpose of the countercyclical buffer is to reduce the downturn in the real economy that would otherwise follow if households' and companies' access to credit are tightened excessively during periods of stress in the financial system. This means that the countercyclical capital buffer should be built up during good times, when risks in the financial system accumulate, and can be released if systemic risks materialise.

In periods of financial stress, the buffer is to be released gradually or fully and the institutions can use the released capital to maintain adequate extension of credit. 

Countercyclical capital buffer

The Minister releases the buffer

As a reaction to covid-19, the Minister for Industry, Business and Financial Affairs decided on 12 March 2020 to reduce the countercyclical capital buffer rate to 0 per cent with immediate effect.

The Council recommends that the countercyclical capital buffer remain unchanged at 0 per cent. The Council expects to recommend an increase of the buffer rate in the middle of 2021 unless risk build-up slows down considerably or there is a new negative shock to the economy. Since it usually takes 12 months from a decision to increase the buffer rate until the increase becomes effective, banks will not be expected to meet a positive buffer requirement until the middle of 2022. In light of the very loose financial conditions it might be necessary to rebuild the countercyclical capital buffer relatively quickly.

In recent years, the Council has focused on increasing credit institution's resilience through a gradual increase in the countercyclical capital buffer. The Council's recommendations to increase the buffer have been followed by the Minister for Industry, Business and Financial Affairs. The aim was to build up a buffer to a size substantial enough to make a difference in case the need to release it emerged. The release of the buffer in face of the uncertainty following the spread of covid-19 is therefore in line with the Council's approach. Releasing the buffer aims to prevent the banks and mortgage credit institutions from reducing credit supply due to capital shortfalls.

According to Danish legislation, the Systemic Risk Council is an advisory body, with the purpose of preventing and reducing systemic financial risks, that may put pressure on all or parts of the economy. The Council shall, according to Danish law, not act in relation to crisis management.

Countercyclical capital buffer

Methodology for assessing the buffer rate

The Council assesses the level of the countercyclical capital buffer rate every quarter. The information base used in the Council's assessment is described in the Council's methodology note.

The Council may make recommendations on the use of the countercyclical capital buffer. It is the Minister for Industry, Business and Financial Affairs who is responsible for the quarterly setting of the buffer rate in Denmark. The minister may either comply with the recommendation or submit an explanation to why a recommendation is not followed.

In 2017 the Council revisited the method to assess the level of the countercyclical capital buffer rate. The previous method was published in 2014. The revision incorporates the Council's own experiences as well as experiences abroad during the three year period. As more experience is gained, the Council will further develop its methodology for setting the buffer rate.

In June 2019, the European Systemic Risk Board, ESRB, assessed that Denmark's method for assessing the buffer rate is in full compliance with the European guidelines.

The data underlying the key indicators used by the Council to assess the level of the countercyclical capital buffer is published after each quarterly meeting of the Systemic Risk Council. In addition to the key indicators, other information is included in the Council's considerations, such as other indicators and policy measures.