Support for Countercyclical Capital Requirements Gains Momentum

Support for Countercyclical Capital Requirements Gains Momentum

After former Council of Economic Advisers Chair Jason Furman made the case for higher countercyclical capital buffers (CCyB) in the opinion pages of The Wall Street Journal, a number of Fed officials are voicing their support for this form of macroprudential regulation.

Unlike a more traditional capital requirement, which would require a consistent level of equity financing across the business cycle, a CCyB would be adjusted on a counter-cyclical basis: banks would be required to hold more capital in good times, reducing their ability to make leveraged investments, but the CCyB would be reduced in bad times, freeing banks up to borrow more and providing a form of stimulus similar to lowering interest rates.

Kate Davidson and Nick Timiraos write on how countercyclical capital buffers have found friends in high places in The Wall Street Journal.

“This would be a good time to be raising that capital buffer,” said Cleveland Fed President Loretta Mester in a July interview. “In good times, you raise it.” Not using it now “puts you more into the camp of” using interest rates to guard against financial instability, she added.

It was a subject of discussion at a Boston Fed conference Friday and Saturday. Ms. Mester is among five regional Fed bank presidents pushing for a move, but the authority isn’t in their hands. Instead, Fed governors in Washington, overseen by board Chairman Jerome Powell, make the decision, voting at least once a year on its level.

One Fed governor, Lael Brainard, has publicly backed increasing the buffer. Mr. Powell hasn’t weighed in publicly, except to say in June he didn’t think financial-stability risks were meaningfully above normal.

One objection to increased capital buffers is that banks currently hold higher levels of capital than in the past: “tier one” capital has increased from 8.5% of assets to 12.7% from 2008 to 2012 for banks with assets over $50 billion. This is welcome news, to be sure, but these figures are still indicative of a highly leveraged financial system.

(For reference, the Minneapolis Plan to End Too Big to Fail estimates that capital requirements of 23.5% and 38% for non-systemically important and systemically important banks, respectively, would reduce the risk of a bailout over the next 100 years to a nine percent chance.)

It’s too early to know if Powell will go along with the plan (though his willingness to raise interest rates, much to the chagrin of the President, indicates he’s not inclined to run the economy “hot” during good times). But CCyBs are another tool to help policymakers prepare for bad times both by insulating banks from a negative shock to the financial system and giving them greater latitude to lend when stimulus is necessary.

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By | 2018-09-10T11:33:36+00:00 September 10th, 2018|Blog, Financial Regulation|