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Countercyclical capital buffer: building the resilience or taming the rapid financial cycle?

Widiantoro, Dimas Mukhlas (2022): Countercyclical capital buffer: building the resilience or taming the rapid financial cycle?

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Countercyclical capital buffer came in 2009 after Basel Committee proposed it through Basel III regulation to build banking resilience and tame the systemic risk due to excessive growth in the credit cycle. Basel committee proposed the credit to GDP gap or credit gap as the indicator of when such buffer is activated. In 2014, the European Central Bank recommended that European Economies adopt the countercyclical capital buffer or CCB in their macroprudential policies. However, in the implementation, every financial authority in EU markets imposed the CCB differently. Some groups use CCB to build resilience as their primary objective. At the same time, the other group attempted not only resilience but also to control the excessive credit growth as their primary objective. The next challenge in implementing CCB is the negative feedback on the usage of the credit gap as the indicator and guidance on setting the CCB rate. The input lies in the Hodrick-Prescott or HP filter containing polynomial drift with a structural break, creating a spurious result. There are two novelties in this paper. First, the paper attempts to see whether the differences in such purposes will affect the country's resilience and ability to tame excessive credit growth. Second, the paper will employ the boosted Hodrick-Prescott filter or bHP from Phillips and Shi (2021) and compare it to the original Hodrick-Prescott filter. The empirical analysis uses data from Germany as the resilience focus market and France focusing on resilience and taming the rapid financial cycle. Using quarterly data from 1999 to 2021, we find that the boosted HP filter significantly improves the accuracy of the credit gap and output gap by removing the polynomial drift in the original HP filter. By analyzing the speed of economic recovery after financial shock, Germany, which focuses primarily on building economic resilience, recovers faster than France. Later, we find no significant difference between the two markets in their ability to tame the financial cycle by analyzing the credit gap cycle after the CCB implementation shock. And last, we find that after 2014, Germany has been able to moderate credit procyclicality, better than the period before.

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