What is Capital Conservation Buffer?
The capital conservation buffer (CCB) is meant to protect banks in times of financial distress. It is in keeping with the rationale behind the Prompt Corrective Action (PCA) system that was part of U.S. capital regulation beginning in 1991. The idea behind it is that when bank capital ratios approach minimums, increasingly stringent regulatory intervention is in order to move banks back to a well-capitalized position.
The CCB requires banks to build up a buffer of Tier 1 equity capital equal to 2.5% of RWAs in normal times, which will then be used to cover losses in stress periods. This means that in normal times a bank should have a minimum 7% Tier 1 equity capital ratio (i.e., 4.5% + 2.5% = 7.0%). Total Tier 1 capital must be 8.5% of RWAs and Tier 1 plus Tier 2 capital must be 10.5% of RWAs in normal periods. Banks need an extra cushion against loss during stress periods. The idea behind the buffer is that it is easier for banks to raise equity capital in normal periods than in periods of financial stress.
Why was Capital Conservation Buffer introduced?
It was introduced after the 2008 global financial crisis to improve the ability of banks to withstand adverse economic conditions.