MNI INTERVIEW: Countercyclical Buffer Too Low -Ex BOE's Aikman

The Bank of England should double the top of its effective range for the countercyclical capital buffer brought in to boost banks’ resilience after the global financial crisis and use it to more aggressively target financial risks, with current settings having little effect, former BOE division head and Federal Reserve advisor David Aikman told MNI.

While in some jurisdictions including the U.S. the buffer is capped at 2.5%, under Basel rules national authorities can implement requirements of more than 2.5%. The BOE has never exceeded this limit, but in Aikman's view doing so would be a more flexible way of enhancing financial system resilience than boosting other capital requirements.

"I would certainly like to see higher baseline capital requirements. But one benefit of the CCyB is that it can be removed in a stress – that’s not the case for other capital requirements, which are procyclical as a result. I think a 0-5% range for the CCyB would be a positive development," Aikman said in an interview.

The CCyB, designed to protect against self-reinforcing credit dynamics where banks cut lending in a downturn or raise it in response to an asset boom, was left unchanged in September by the BOE’s Financial Policy Committee at 2%, its neutral rate. It has never set it higher than 2.5%. Recent modelling by Aikman and other central bank economists found that use of the buffer has been overly cautious and that economic outturns improved markedly if the CCyB is deployed in response to changing financial stability risks rather than solely in tune with the interest rate cycle.

"I’d like to see the BoE increase the CCyB further. It seems self-evident to me that we are not in a neutral risk environment at the moment. Banks need larger capital cushions to make them resilient to the risks they face," Aikman said.

SHADOW BANKS

Still, he acknowledged that the power of the tool is being diluted as non-bank financial institutions (NBFIs) increasingly drive changes in credit growth, a point highlighted by BOE markets director Andrew Hauser in a recent speech at an MNI event.

"In our model, we do find that it’s optimal to use the CCyB less when the share of NBFIs in providing credit grows. That’s just because the impact of the tool is diminished," said Aikman, now head of Kings College Business School.

“This really just highlights the need to develop macropru tools for NBFIs. And even though the share of banks in overall financial system assets has declined, banks still play a really important role in liquidity provision and their resilience is still of paramount importance," he added.

In the UK at present the picture is tricky, with credit availability declining to levels not seen since the post financial crisis period, outside of the Covid shock, according to BOE data, while interest rates have risen sharply and financial risks are perceived to have increased.