Bank Credit Risk and Macro-prudential Policies: Role of Counter-cyclical Capital Buffer

This paper investigates the impact of counter-cyclical capital Buffer (CCyB) as a macro-prudential policy, on bank credit risk, during uncertain times, as banking sector stability is crucial in promoting financial intermediation. Using a unique daily data set consisting of 4939 credit default swaps (CDS) of 70 banks from 25 countries over the period 2010-2019, we find that CCyB tightening decreases bank-level CDS spread while CCyB loosening increases CDS spread. This heterogeneous effect of CCyB arises due to its asymmetric effect on the capital ratio (equity-to-total assets) of banks. Tightening CCyB significantly increases capital, whereas loosening CCyB does not impact capital. Thus, by imposing on banks to hold capital buffer, the CCyB regulation enables them to mitigate any rise in credit risk during uncertain times when bank assets lose value. Therefore, macro-prudential policies for banks to hold higher levels of capital during good times are justified to contain financial market risks during downturns.

Keywords: Bank CDS, macro-prudential policy, bank-level characteristics, macroeconomic environment uncertainty

Authors: Nadia Benbouzid, Abhishek Kumar, Sushanta Mallick, Ricardo M Sousa,  Aleksandar Stojanovic

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