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Signaling a “neutral” level for the CCyB above the current 0.5% of RWAs.
2024/05/07 | Andrés Pérez M., Vittorio Peretti & Ignacio Martinez Labra

The BCCh’s 1S24 Financial Stability Report (FSR) notes external risks as the most relevant for domestic financial stability. The FSR highlights tight global financial conditions and elevated uncertainty regarding the timing and intensity of the Fed’s easing cycle, generating sharp swings in rates and asset prices. Separately, long term rates remain elevated, as risks of even higher sovereign debt linger throughout the global economy. Geopolitical uncertainty remains high, placing risks on the inflation outlook, and the appropriate expected monetary policy response in advanced economies. In this context, the FSR flags as main external risks a sudden tightening of global financial conditions, the effects of a prolonged period of elevated long-term interest rates, and risks from non-residential real estate in advanced economies.


On the domestic front, the FSR states that the Chilean economy has resolved the macro-financial imbalances of previous years. The resolution of the imbalances has allowed for a normalization of the financial situation faced by borrowers, including their financial burden and debt. However, the recovery in economic activity has been uneven, with certain sectors lagging, including smaller sized firms, those that borrowed state-guaranteed loans during the pandemic (Fogape-Covid), and certain sectors such as retail, construction, and real estate. The FSR states that prudent fiscal management is crucial in maintaining access to external financing, without abrupt changes in borrowing costs.


Bank credit has been in line with the cyclical adjustment of the economy. While commercial loans continue to contract, driven mainly by weak demand, consumer loans have moderated their annual declines, and mortgage loans have remained steady. In this context, delinquencies have increased above historical patterns in consumer and commercial loans, as we have highlighted monthly with data from the Financial Market Commission. Furthermore, the BCCh analyzed that the policy actions of: the standardization of FCIC-eligible collateral, the creation of the Basel III Conservation Cushion and the activation of the Counter-Cyclical Capital Buffer (occurring between the second half of 2022 and the first half of 2023). The BCCh’s analysis suggests that these measures did not seem to have a significant negative effect on aggregate credit supply, however, they may have had an impact at the individual level.


No stress. Importantly, the BCCh’s stress tests show that the domestic banking system has sufficient capital levels to face severe stress scenarios, as well as buffers above regulatory requirements. However, the BCCh notes that the phased-in implementation of Basel III will lead to higher capital requirements for the banking system and should hence continue bolstering its capital base.


The BCCh maintained the Counter-Cyclical Capital Buffer, as expected. Leading up to the publication of the FSR, the BCCh held its first Financial Policy Meeting of the year, with the Board unanimously deciding to maintain the counter-cyclical capital buffer (CCyB) at 0.5% of risk-weighted assets (RWAs). The BCCh originally raised the CCyB as a precautionary measure from 0 to 0.5% of RWAs in May of 2023, to be implemented by the end of May 2024. The CCyB was maintained in the second Financial Policy Meeting of 2023, last November. However, the BCCh called the banking system to continue strengthening its capital base, and states they are working on a framework for the implementation of the CCyB, including its so-called “neutral” level. In our view, put together these messages suggest the neutral level is likely to be set above the 0.5% of RWAs.


Our take:  The BCCh’s FSR appropriately stresses the relevance of external risks to the Chilean economy, which put together with narrowing interest rate differentials, should keep exchange rate volatility high. While not mentioned, new withdrawals from pension fund savings, to be discussed in the Lower House of Congress in June, are an important domestic tail-risk to monitor, if approved. We interpret certain messages in the text as hinting towards a “neutral” level for the CCyB above the current 0.5% of RWAs. The Financial Policy meeting’s minutes are scheduled to be released on May 22, and the next Financial Stability Report will be held on November 18-19.