Basel III: Countercyclical capital buffer proposal – the case of Latvia

Abstract

An objective of the countercyclical capital buffer is to encourage banks to build up buffers in good times that can be drawn down in bad times.

The purpose of the research presented in the paper is to assess countercyclical capital buffer implementation in the Latvian banking sector derived from two approaches, using credit-to-GDP ratio and using credit growth ratio.

Methodology. The countercyclical buffer approaches in use are the aggregate credit-to-GDP ratio and its trend as well as credit growth and its trend. The approaches are implemented for Latvia for the time period 2000-2012. The report compares two approaches and analyses their relevance to Latvia by testing the correlation between a growth in studied variables and a growth of corresponding gaps, which triggers decisions to establish a countercyclical capital buffer. Also, the impact of each approach on countercyclical capital buffers is assessed and two approaches are mutually compared. Methods used in the empirical part of the report are econometric analysis, including analysis of regression, as well as economic analysis, including main trend analysis, development indicators, relative and absolute indicators and other methods.

Results and findings. The research outcome is a comparison of two alternative approaches to establish or release a countercyclical capital buffer by banks and their implications for Latvia.

Originality. The research paper implements two alternative approaches recommended by the Basel Committee to establish or release a countercyclical capital buffer by banks in case of Latvia for the retrospective period 2000-2012.