Introduction to 'Basel III and Beyond'
The Big Financial Crisis
The Policy Response: From the G20 Requests to the FSB Roadmap; Working Towards the Proposals of the Basel Committee
The New Definition of Regulatory Capital
A New Framework for the Trading Book
Counterparty Credit Risk and Other Risk-Coverage Measures
Tools for Mitigating the Procyclicality of Financial Regulation
The Regulatory Leverage Ratio
The New Framework for Liquidity Risk
The Discipline of Credit Rating Agencies
Systemically Important Banks
Regulating Remuneration Schemes in Banking
Crisis Management and Resolution
The Impact of the New Regulatory Framework
A Brazilian Perspective on Basel III
A New Institutional Framework for Financial Regulation and Supervision
Structural Regulation Redux: The Volcker Rule
The Changing Uses of Contingent Capital under the Basel III Framework
This article was first published as a chapter in Basel III and Beyond, by Risk Books.
This chapter deals with the issue of procyclicality in the financial sector. First, it describes how capital regulation can amplify the natural fluctuations of bank intermediation. Second, it provides a comprehensive overview of the measures adopted by the Basel Committee on Banking Supervision (BCBS) for mitigating procyclicality as well as tackling the shortcomings of the Basel II framework.
The nature of credit markets and their imperfections make banks’ activity inherently cyclical. Unquestionably, a certain degree of cyclicality is expected and somehow desirable since it reflects the link between the banking and the nonfinancial sectors. Cyclicality turns into a policy concern – procyclicality – when it contributes to the amplification of economic cycle fluctuations and undermines the stability of the financial system. Indeed, the crisis has shown with dramatic clarity to what extent flawed regulatory frameworks and poor supervision can reinforce the cyclicality of the financial sector. In the aftermath of the crisis, when recessionary conditions spread worldwide, it