Central Bank Raises Capital Buffers to Enhance Resilience Skip to content
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Photo: Golli. Central Bank Governor Ásgeir Jónsson.

Central Bank Raises Capital Buffers to Enhance Resilience

Iceland’s Central Bank published its semi-annual Financial Stability report today. As noted in the report, the Financial Stability Committee has decided to increase the countercyclical capital buffer rate from 2% to 2.5%, a record high. The report also notes that although the financial system is “on solid footing,” the finances of households and companies continue to deteriorate due to persistent inflation.

The Financial Stability Committee

This morning, the Central Bank’s Financial Stability Committee (FSN) released its semi-annual Financial Stability report. The report presents an overview of the position of the financial system, its strengths and potential weaknesses, and the macroeconomic and operational risks it may face.

The report notes that the “systemically important banks” – whose capital and liquidity positions are strong – have delivered solid results and managed to provide support to households and businesses, the latter of which have struggled:

“Households’ and businesses’ financial conditions are tightening because of high inflation and interest rates. The outlook is for inflation to be stubbornly high and debt service burdens to grow heavier,” the report reads.

FSN also notes that the struggle of financial companies in international markets should serve as a reminder of the need for depository institutions to maintain sufficient strength so as to fulfil their roles, and that – given that domestic demand was strong and that developments in the financial markets were uncertain – it was “important to preserve the resilience of domestic financial institutions.”

Enter the countercyclical capital buffer.

Countercyclical capital buffer

As noted in an article in Vísir, during the restructuring of the banking system after its collapse in 2008, the defences of the financial system were strengthened and various safeguards were put in place. Among other things, a so-called countercyclical capital buffer was introduced, which is a requirement that the banks accumulate capital to create buffers to enhance the resilience of the banking sector during periods of stress. It was abolished in the fall of 2020 but reinstated last year (at 2%).

As noted in the Financial Stability report, the FSN has decided to increase the countercyclical capital buffer rate from 2% to 2.5%, a record high. (The Committee’s decision will take effect twelve months from now.)

Vísir quoted Governor of the Central Bank Ásgeir Jónsson as saying that this increase should serve to, on the one hand, “slow down the banking system’s lending,” and, on the other, be of benefit in case there is “a hard landing in the economy in a year or two.” “So with these measures, we are actually trying to slow down the financial system,” Ásgeir observed.

As noted by Vísir, Ásgeir was unwilling to comment on the likelihood of the Central Bank further raising the interest rate (the decision will be announced on Wednesday next week); most forecasters expect the interest rate to rise by up to 0.75%. It would be the Central Bank’s twelfth interest rate increase in a row.

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