This is especially the case if no other firm in their peer group is subject to these measures, creating a collective action problem: firms, acting out of perceived individual interest, may choose to restrict their lending to the real economy rather than dip into their CCoB. But actions that can seem rational for each firm individually can prove damaging in aggregate for the economy and banking system as a whole. By way of illustration: stress tests carried out by the Bank of England in the early phases of the Covid crisis suggested that the direct gain to banks of preserving capital by not lending were small – adding c. 0.1 percentage points in capital ratio terms. In contrast, they showed that the costs to the wider economy, and ultimately the banking system, from not lending could be very large: reducing aggregate bank capital ratios by as much as 0.8 percentage points due to negative feedback to banks’ credit exposures from worse unemployment and corporate insolvency outturns over time when lending is restricted.11 Finally, just before management buffers are Countercyclical Capital Buffers (CCyB) which, when non-zero, operate as an extension of the Capital Conservation Buffer and can be released during generalised stresses.12 The key issue here is that there may be stigma associated with use of a regulatory buffer.
It ties up resources without providing the extra capacity in stress that regulators wanted them to provide, and had assumed they would when determining how to prepare the system to absorb shocks. If a regulatory buffer is instead perceived as similar to a minimum requirement and firms take actions to avoid dipping into it, these actions might be harmful to the real economy and, as last year’s Bank analysis showed, to the banking system. Thus it is essential to have a well-designed regulatory buffer framework which can make fresh resources available when they are most needed. The early Covid stress gives us an opportunity to investigate how the current framework behaves and how practically usable regulatory buffers may be. Given the effectiveness of the fire-fighting I mentioned at the outset, bank capital ratios did not approach their Capital Conservation Buffers, so we cannot probe directly how banks would have behaved had capital ratios fallen inside that regulatory buffer. However, there are at least three approaches we can look at. Approaches to analysing capital buffer usage Approach 1 – What do banks and investors say about buffers? The first approach involves asking banks what constraints they face in practice in dipping into buffers and how they manage their capital positions. In broad terms, they told us that expectations of capital instrument and debt investors and concerns about the actions of credit ratings agencies are a major constraint.