The financial indicators of the Latvian banking sector are good, and the Macroprudential Council believes that under these circumstances a farsighted step should be taken to build capital buffers of credit institutions or pursue the principle "make the cart in winter and the sledge in summer".
The Macroprudential Council1, at its meeting of 19 July 2023, discussed the major systemic-level risks to financial stability and the macroprudential policy measures required to support financial stability. The Macroprudential Council concluded that the financial indicators of the banking sector are good and that the conditions are now appropriate to strengthen the resilience of the banking sector.
Latvian credit institutions have high voluntary capital buffers, good profitability indicators and overall low financing costs. At the same time, respective risks should be taken into account, inter alia, considering the experience and developments from the recent past in the context of the pandemic and the war in Ukraine launched by Russia. Large-scale shocks may occur unexpectedly and suddenly, uncertainty remains high. Moreover, the Latvian economy is particularly exposed to external developments due to its size and openness. Therefore, it would be prudent to use the good financial conditions to build additional resilience with respective reserves in a timely manner in case hard times set in and risks may materialise. Furthermore, the current financial conditions of credit institutions make it possible to strengthen resilience without adverse procyclical effects.
In the view of the Macroprudential Council, in these conditions an appropriate step is the introduction of the so-called positive neutral countercyclical capital buffer approach, which is increasingly gaining international support and is already implemented in the region – in Lithuania, Estonia and Sweden – the countries relevant for our financial sector.
This approach means that during the neutral phase of the financial cycle where the cyclical systemic risk is neither increased nor substantially low the countercyclical capital buffer rate is maintained at a certain baseline level which is above zero (positive) rather than zero, e.g. at 1%. Currently, the requirement for the countercyclical capital buffer rate in Latvia is set at 0%.2The latest decision on the countercyclical capital buffer rate of 0% was taken on 27 April 2021, please see likumi.lv/ta/id/322793
The positive neutral countercyclical capital buffer approach allows for building the countercyclical capital buffer earlier in the financial cycle to ensure that additional capital buffer is available in the banking sector when risks materialise suddenly. This capital buffer increases the resilience of credit institutions in a crisis situation in which case they can use it to continue lending to the economy.
Considering the implementation period of the countercyclical capital buffer as laid down in European Union regulation (12 months after the date of the announcement of a decision), a gradual implementation of the positive neutral countercyclical capital buffer approach will be initiated in December 2023, within the framework of a quarterly countercyclical capital buffer assessment process, by making a decision that the requirement on the countercyclical capital buffer rate of 0.5% takes effect as of December 2024 and at the rate of 1.0% – as of June 2025. The current financial situation of Latvian credit institutions allows maintaining this buffer in full without raising additional capital.
1 One of the tasks of Latvijas Banka is to enhance the stability of Latvia's financial system at macro level. Financial stability means that the financial system can perform its core financial intermediation function without significant disruptions and negative effects on economic growth both in peaceful times and in times of turbulences.
To achieve the financial stability goal more efficiently, in 2013, Latvijas Banka, the Financial and Capital Market Commission (FCMC) and the Ministry of Finance (as the leading public administration authority that implements the financial sector policy) signed a cooperation agreement and established the Macroprudential Council. It is a collegial permanent consultative body for mutual cooperation with the aim to promote the stability of Latvia's financial system as a whole. In the Macroprudential Council, the parties hold consultations about the systemic risk assessment and the measures to mitigate these risks, as well as exchange information, while understanding and having regard to the independence of decision-making within their respective areas of responsibility.
Following the FCMC integration into Latvijas Banka, the trilateral cooperation transformed into a bilateral cooperation forum respectively – into a cooperation forum of Latvijas Banka and the Ministry of Finance. More on changes in the macroprudential institutional framework after the FCMC integration into Latvijas Banka on 1 January 2023.