Filter selection for countercyclical capital buffers

Abstract

Background: Procyclicality plays a pivotal role in finance in both thriving and crisis periods. This influence stems not only from the way market participants behave but also from risk metrics used and regulatory capital amassed and released during bust and boom periods, respectively. The introduction of the regulatory Countercyclical Capital Buffer aims to thwart procyclicality by accumulating (releasing) capital in upswings (downswings), subsequently reducing the amplitude of the financial cycle and promoting macroprudential stability. The timing of the accumulation and release of buffer capital is critical so identifying accurate indicators is important. Aim: This paper applies a Kalman filter to South African data and confirms the procyclicality of the Basel Committee on Banking Supervision (BCBS) proposal. Setting: For South Africa, studies suggest alternatives such as residential property indices because research has demonstrated that the BCBS proposal is procyclical rather than countercyclical. Methods: This paper applies a Kalman filter to South African data and compares the results obtained with those filtered using the Hodrick–Prescott filter. Results: Results indicate that buffer signals are dependent upon the filter employed. Conclusion: Buffer signals are strongly dependent upon the filter employed to detect procyclicality. The South African Reserve Bank and other regulators should reconsider the use of the Hodrick–Prescott filter and entertain the possibility of using the Kalman filter instead.

Stability of financial development: Problems of measurement, assessment and regulation

“…At the same time, within the framework of the second direction, models for assessing the cyclic components of the credit GAP or its transformations, as well as early warning models are distinguished. Recommendations for the use of alternative statistical filters occupy an important place in the study of the cyclic component [ 41 , 42 ].…”

The Effectiveness of Banking Countercyclical Policies in the Development of Priority Economic Sectors in Indonesia

“…According to BCBS (2010), the deviation of the ratio and GDP from its long-term trend is an indicator that shows a better signal performance for the need to build capital before the crisis. Most banking crisis were identified with excessive credit growth (Bonfim & Monteiro, 2013;Borio & Drehmann, 2009;Pfeifer & Hodula, 2021;Reigl & Uusküla, 2021;Reinhart & Rogoff, 2011;Schularick & Taylor, 2009;Visser & Vuuren, 2018;Wezel, 2019).…”

“…So it can be said that the buffer signal is very dependent on the filter used to detect procyclicality. The banking industry and regulators should reconsider using the Hodrick-Prescott filter and explore the possibilities of using the Kalman filter instead (Visser & Vuuren, 2018).…”