Calibrating the Magnitude of the Countercyclical Capital Buffer Using Market‐Based Stress Tests

Abstract: This paper proposes a novel methodology to calibrate the magnitude of the countercyclical capital buffer (CCyB) using market‐based stress tests. The macroprudential authority in our paper aims to contain the possibility of a breach of a minimum capital ratio in the event of a severe system‐wide shock within a certain permissible failure probability. We apply the methodology by stress‐testing major banks in six advanced economies on a quarterly basis over a period of 27 years. The estimates suggest that the cap on the CCyB should not be less than around 1.7% of total assets. Its potential normal‐times level is estimated at approximately 0.8% of total assets.