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Buffer usability in a complex world: Interactions between macroprudential regulation and the resolution framework
This paper explores the interplay between the risk- and leverage-based prudential
and the resolution frameworks within the EU banking system. The prudential
framework is designed to enhance the resilience of both individual banks and the
banking sector as a whole. It does so by imposing minimum capital requirements
and capital buffers that can absorb losses during periods of financial stress.
Conversely, the resolution framework focuses on ensuring that banks have adequate
loss-absorbing and recapitalisation capacity to facilitate an orderly resolution
process, thereby safeguarding public funds. The simultaneous use of capital across
and within these two frameworks can have an impact on the effectiveness of capital
buffers, presenting various challenges for macroprudential authorities. Our analysis
shows that overlaps between risk-based and leverage-based requirements within the
prudential framework reduce buffer usability to around 65% to 74% of the overall
combined buffer requirement. When the resolution framework is also considered,
buffer usability further declines to an average of 40% to 50%, depending on the
analytical approach employed. Our simulations of buffer usability under different
regulatory options discussed in the literature suggest that implementing the final
Basel III standards in the EU would significantly increase buffer usability. The paper
also analyses the impact of other options that could reduce or eliminate overlaps
between capital buffers and other parallel requirements and quantifies the trade-offs
between increased buffer usability and the costs of implementation. As resolution
requirements are fully phased in as of 2024, the future evolution of buffer usability
and the potential challenges for macroprudential authorities will also depend on how
banks set their capital targets relative to the parallel frameworks and how they adapt
their balance sheet structures to meet prudential and resolution requirements.
and the resolution frameworks within the EU banking system. The prudential
framework is designed to enhance the resilience of both individual banks and the
banking sector as a whole. It does so by imposing minimum capital requirements
and capital buffers that can absorb losses during periods of financial stress.
Conversely, the resolution framework focuses on ensuring that banks have adequate
loss-absorbing and recapitalisation capacity to facilitate an orderly resolution
process, thereby safeguarding public funds. The simultaneous use of capital across
and within these two frameworks can have an impact on the effectiveness of capital
buffers, presenting various challenges for macroprudential authorities. Our analysis
shows that overlaps between risk-based and leverage-based requirements within the
prudential framework reduce buffer usability to around 65% to 74% of the overall
combined buffer requirement. When the resolution framework is also considered,
buffer usability further declines to an average of 40% to 50%, depending on the
analytical approach employed. Our simulations of buffer usability under different
regulatory options discussed in the literature suggest that implementing the final
Basel III standards in the EU would significantly increase buffer usability. The paper
also analyses the impact of other options that could reduce or eliminate overlaps
between capital buffers and other parallel requirements and quantifies the trade-offs
between increased buffer usability and the costs of implementation. As resolution
requirements are fully phased in as of 2024, the future evolution of buffer usability
and the potential challenges for macroprudential authorities will also depend on how
banks set their capital targets relative to the parallel frameworks and how they adapt
their balance sheet structures to meet prudential and resolution requirements.
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