A countercyclical buffer is a macroprudential policy tool used by central banks to ensure that banks and other financial institutions have enough capital during periods of economic growth to absorb potential losses during a downturn.
The buffer is designed to be increased during economic booms and decreased during economic downturns. This is meant to help stabilize the financial system and reduce the risk of bank failures and the need for government bailouts.
During a period of economic growth, banks are required to increase their capital buffers beyond the minimum required level. The additional capital acts as a cushion to absorb losses during a downturn. During an economic downturn, banks can draw on this buffer to maintain lending and avoid reducing credit availability, which can exacerbate the economic downturn.
The countercyclical buffer is one of several macroprudential policy tools used by central banks to promote financial stability. Other tools include loan-to-value ratio limits, capital requirements, and stress testing.
In Nepal, the Nepal Rastra Bank (NRB) is responsible for implementing such policies. Nepal Rastra Bank has mentioned Countercyclical Buffer in its recent unified directives 2079/080 and ordered “A” class commercial banks to maintain countercyclical buffer from F/Y 2080/81.
The NRB had conducted a study on the countercyclical buffer’s potential impact on the Nepalese financial system and concluded that it could help mitigate the negative effects of economic cycles on financial stability.
