How Effective Is the Relaxation of the Countercyclical Capital Buffer at a Time When Other Residential Macro-prudential Tools Are Tight?

How effective is the relaxation of the countercyclical capital buffer (CCyB) at a time when other residential macro-prudential tools are tight? Evidence in this chapter shows that GDP growth increases in response to loosening in the mortgage market credit conditions index (MMCI) while the excess capital adequacy ratio (CAR), the repo rate and the lending spreads also decline. The loosening in the MMCI is transmitted via a decline in the repo rate and lending spreads which in turn raises GDP growth. The decline in excess CAR is also largely transmitted via the loosening of the MMCI and the lending rate spreads. The decline in excess CAR and loose lending conditions imply an accommodative monetary policy stance. The results show that GDP growth and inflation increase more in response to loose MMCI compared to an unexpected reduction in excess CAR. But a decline in the CCyB, because it is a credit supply shock, depresses the lending rate spread more than the loosening in the MMCI shock. This means that a lower CCyB shock and the loosening of the MMCI shock are transmitted into bank lending via the same channels but exert different effects. Furthermore, loose MMCI and the reduction in the CCyB reinforce each other’s effects and those of accommodative monetary policy on GDP growth and the compression in the lending rate spreads. Thus, the relaxation of the CCyB is more potent when other residential macro-prudential tools are loosened. The relaxation of the CCyB and loose lending conditions complement accommodative monetary policy and move the lending rate spread and GDP growth in the same direction. Hence, these tools need to be systematically co-ordinated to have the desired effects on real economic activity.