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TEXT-Czech central bank's June 18 financial stability meeting minutes

Wed 8th July, 2020 8:00am
PRAGUE, July 8 (Reuters) - Following is the full text of the
minutes from the Czech central bank (CNB) governing board's June
18 meeting on financial stability, released on Wednesday.
    Present at the meeting: Governor Jiri Rusnok, vice-governors
Marek Mora and Tomas Nidetzky, board members Vojtech Benda,
Oldrich Dedek, Tomas Holub and Ales Michl.
    The meeting opened with a presentation of Financial
Stability Report 2019/2020, which focused mainly on risks to the
future stability of the domestic financial sector associated
with the COVID-19 pandemic, the turnaround in the financial
cycle, an assessment of banking sector resilience, and changes
in the level of risks connected with mortgage lending. Following
the opening presentation, the Bank Board discussed the setting
of the countercyclical capital buffer (CCyB) rate, the capital
cushions necessary to maintain stability even in the case of
highly adverse developments, and additional potential changes to
macroprudential instruments targeted at risks connected with
mortgage lending.
    The presentation given by the Financial Stability Department
on the CCyB emphasised that, according to the aggregate
Financial Cycle Indicator as well as other indicators, the
domestic economy had entered the recessionary phase of the
financial cycle this year. Despite a sharp economic
deterioration, the cyclical risks accepted in the previous
expansionary phase of the cycle were not materialising
systemically in the banking sector so far. However, the
deterioration in the economic conditions would be manifested in
a drop in credit portfolio quality and a rise in credit losses
in the quarters ahead. Increasing default rates would probably
also lead to a gradual rise in risk weights. In this situation,
the Financial Stability Department preferred to proceed in line
with the recently published methodology, according to which the
CCyB rate was to be lowered gradually in connection with the
materialisation of the above risks. A gradual release of the
existing CCyB should support the ability of banks to finance the
real economy.
    In the discussion that followed, the board members agreed
that the financial cycle had entered the recessionary phase and
newly accepted cyclical risks would be decreasing. There was
also a consensus that the domestic banking sector would be faced
with materialisation of previously accepted cyclical risks and
that releasing the CCyB was a desirable reaction. The first step
had been the preventive forward-looking March decision to lower
the CCyB rate from 1.75% to 1% with effect from the start of
April. The main subject of the Bank Board's subsequent
discussion was whether to cut the rate further now in view of
the evident future increase in credit losses or to wait until
increased losses start to occur. In support of immediate
continuation with the release of the CCyB, it was said that in
the situation the economy is now in, macroprudential policy
should react anti-cyclically and do its utmost to mitigate the
risk of a deteriorating capital position of banks adversely
affecting the price and availability of credit. Other board
members argued that, at their current level of capitalisation,
banks had considerable lending capacity and a CCyB rate of 1%
would not constitute a barrier to the supply of credit. In
addition, it was discussed how, if the rate were lowered, to
meet the regulatory requirement to indicate a time horizon at
which the CCyB rate might be increased again. There was a
consensus that the horizon would probably be relatively long
and, given the exceptionally high level of uncertainty, any
indication would constitute merely formal compliance with the
regulatory rules. Moreover, when a cycle of lowering the CCyB
rate is under way, such an indication could be confusing to the
general public.
    The subsequent part of the Bank Board's discussion focused
on the CNB's approach to the use of banks' capital buffers (the
capital conservation buffer and the systemic risk buffer) to
absorb losses. The discussion reacted to the international
debate about whether banks would prefer to curb lending due to
concerns of stigmatisation should their capital ratio fall below
the sum of Pillar 1, Pillar 2 and the buffers. The Bank Board
agreed with the expert position according to which the buffers
are clearly defined in EU law as a buffer to absorb banks'
losses in bad times. It was therefore natural that, in the case
of highly adverse developments in the domestic economy, banks
temporarily would not comply with the capital conservation
buffer and the systemic risk buffer after a potential full
release of the CCyB, in order to provide services to their
clients without interruption. This needed to be clearly
communicated to banks, as they so far did not have practical
experience with the use of capital buffers and the regulator's
approach to this issue.
    In connection with the results of the macro stress test of
banks and future adjustments to the EU rules for setting capital
buffers for systemically important institutions, the Bank Board
also discussed the size of the total capital cushions necessary
to maintain banking sector stability even in the case of highly
adverse developments. The board members agreed that banks'
current capital position was highly robust. Banks' resilience
was also supported by retained earnings from last year and
expected positive net profit also this year. At the same time,
it could not be overlooked that the strong capital position was
largely due to a capital surplus on top of the regulatory
requirements and to earnings retained in conformity with the
recommendations of the CNB and other European authorities (EBA,
ESRB). As the recommendation of EU authorities to refrain from
distributing earnings was to expire this year, there could be
pressure to make sizeable dividend payments next year, even
though the final impacts of the coronavirus crisis would be far
from known. In addition, after the transposition of CRD V/CRR II
into Czech law, the CNB would have to use the capital buffer for
other systemically important institutions (the O-SII buffer)
instead of the systemic risk buffer. As the CNB would be able to
set the upper limit on the O-SII buffer no more than 1 pp above
the foreign parent institution's buffer as set by its domestic
regulator, the buffer rates of some domestic systemically
important banks would in all probability decline. On the basis
of an assessment of the above information, the view prevailed
that premature withdrawal of a significant part of banks'
capital surplus could become a source of systemic risk. Banks
should thus refrain from making dividend payouts and taking any
other action that might jeopardise their resilience until the
uncertainty regarding the impacts of the coronavirus crisis on
the banking sector disappears. The CNB stood ready to use all
its supervisory and regulatory instruments to maintain the high
resilience of the banking sector and its ability to lend to the
real economy.
    Developments in the non-banking financial institutions
sector were also presented and discussed. According to the
stress tests, the insurance sector remained resilient to risks
and the capitalisation of pension management companies also
appeared sufficient. Investment funds, which had allocated their
assets in a riskier way in the previous period, should also be
able to cope with the impacts of the coronavirus crisis.
    The second part of the meeting focused on risks connected
with mortgage lending and the residential property market.
According to the presentation given by the Financial Stability
Department, apartment price overvaluation had grown slightly
further in the second half of 2019, reaching 15%-25% at the end
of last year according to both methods used by the CNB.
According to available unofficial data for the first months of
2020, the pandemic had not significantly affected transaction
prices so far. The estimate based on the Baseline Scenario did
not expect prices to decrease either. Given the adverse
developments in the real economy, however, there was potential
for prices to decrease in the quarters ahead. The mortgage loan
market had gradually recovered in the second half of 2019. In
the first four months of this year, the volume of genuinely new
mortgage loans had reached a record high compared with the same
period in previous years. However, it could be expected that the
impacts of the coronavirus crisis would manifest themselves in
the months ahead and activity in this credit segment would
decrease. The spiral between credit financing of property
purchases and optimistic expectations of a future rise in
property prices should halt as a result. The share of loans with
LTVs of 80%-90%, which could account for a recommended maximum
of 15% of new loans last year, had been below the recommended
limit throughout 2019. However, some banks had continued to
provide some loans with an individual LTV of over 90%, the level
above which no loans should have been provided under the then
valid Recommendation. As a result, they had provided more than
15% of new loans with an LTV of over 80%. Banks overall had been
mostly compliant with the 5% exemption for loans with a DTI of
over 9 and had only slightly exceeded this exemption for loans
with a DSTI of over 45%.  However, some of them had exceeded the
DSTI exemption more markedly in the second half of last year.
    In the subsequent discussion, the Bank Board focused mainly
on potential reactions to a substantial change in market
conditions. It agreed that the change of the rules effective
from 1 April 2020 in the form of a softening of the LTV limit
and the abolition of the recommended DTI limit had been an
appropriate reaction in light of the subsequent developments.
The Bank Board's view that, given the expected economic impacts
of the coronavirus pandemic, lenders and their clients would be
well aware of the risks and act in a conservative way, was also
being confirmed. On the basis of information from the Bank
Lending Survey, according to which banks had tightened their
assessment of loan applicants' income situation, the possibility
of abolishing the DSTI limit was discussed. Opinions were voiced
that the limit on this indicator was important from the
perspective of consumer protection and therefore remained of
importance in bad times as well. However, the macroprudential
view, according to which this limit would not be necessary in
the near term given the absence of optimistic expectations,
prevailed. Nevertheless, the Bank Board deemed it necessary to
continue to point out to lenders that loans could usually be
regarded as very risky above certain DTI and DSTI thresholds (a
DTI of 8 and a DSTI of 40%). Lenders should therefore provide
such loans with increased caution and only to applicants who are
highly likely to repay without problems.
    The discussion of the setting of the LTV limit also included
views supporting its abolition or further slight easing.
However, the opinion prevailed that, given the persisting house
price overvaluation and the great uncertainty regarding future
price developments, it was desirable to keep the existing limit
of 90%. Specific cases should be covered by the 5% exemption. It
was also said in support of maintaining an LTV limit that it had
an important signalling role for loan applicants to invest at
least some of their own savings in the purchase of housing. No
later than at its November meeting, the Bank Board would
reassess whether it would be necessary to amend the rules for
mortgage lending by banks depending on market developments.
    Following the presentation of the Financial Stability Report
and the subsequent discussion, the Bank Board decided to lower
the countercyclical capital buffer rate for exposures located in
the Czech Republic to 0.5% with effect from 1 July 2020. It
confirmed the LTV limit of 90% and abolished the DSTI limit.

 (Reporting by Jason Hovet)
 (( 234 721 617)(Reuters
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