Countercyclical capital regulations could benefit from a rule-based approach, according to Cleveland Fed researcher

Quick Take:

• Financial regulators are increasingly looking at bank capital regulation to provide macroeconomic stability in the face of business cycle fluctuations
• Current discretion-based policies being rolled out in Basel III may have small countercyclical impact
• Regulators could consider a rule-based approach to make capital regulation more countercyclical

In the wake of the most recent financial crisis, there's been increased interest in the use of capital requirements to help stabilize the macroeconomy, and generally enhance social welfare, by dampening business cycle fluctuations. Countercyclical capital regulation tightens capital requirements during economic expansions, building a buffer that can be drawn down in less robust times, and loosens these restrictions during recessions.

Federal Reserve Bank of Cleveland economist Filippo Occhino examines two new policy tools within Basel III, the capital conservation buffer and the countercyclical capital buffer, to evaluate their potential to make capital regulation more countercyclical. Partly because these two buffers are not explicitly designed to vary with the business cycle, Occhino says their countercyclical impact may be small.

Instead, Occhino considers the possibility of using rule-based buffers for internationally active banks that would automatically increase during expansions and decrease during recessions. "A rule-based approach could help regulators commit to raising the buffer during expansions and achieve a greater degree of countercyclicality," says Occhino.

Read the commentary, "Are the New Basel III Capital Buffers Countercyclical? Exploring the Option of a Rule-Based Countercyclical Buffer," here.

Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.

The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

Media contact

Doug Campbell, doug.campbell@clev.frb.org, 513.455.4479