Towards a sectoral application of the countercyclical capital buffer: A literature review

The aim of this paper is to review the existing literature on the (sectoral) countercyclical capital buffer. Since the literature directly addressing this topic is relatively scarce, we also include relevant papers that are only indirectly related. We draw insights from the theoretical and empirical literature and use these to shed light on whether the countercyclical capital buffer (CCyB) setting in the Basel III framework could be extended towards a sectoral application of the CCyB. Rather than aiming at providing an exhaustive overview of the literature reviewed, the aim is to draw focused messages that could serve as sufficiently grounded arguments in the debate. Overall, the literature review shows that there is a justified need for sectoral macroprudential tools, and that a sectoral CCyB may be a useful complement to both the Basel III CCyB and existing targeted instruments in the macroprudential toolkit. Yet, countercyclical capital buffers, both broad-based and sectoral, remain largely untested and more empirical work is needed to assess their ability to achieve the different objectives that may be attributed to them. Furthermore, a sectoral application of the CCyB entails several operational challenges, such as defining modalities on when to activate a sectoral CCyB and on its interactions with the Basel III CCyB as well as with other (targeted) instruments. It would also add an additional layer of complexity to the macroprudential capital buffer framework. While they are crucial for the further development of the policy framework on a sectoral CCyB, such operational issues are beyond the scope of this paper.