Don’t count on buffers

One possible mitigator of the pro-cyclical impact of risk-sensitive capital requirements would be counter-cyclical changes in capital buffers. Empirical evidence on this issue is scarce and a new regulatory capital regime could well induce a behavioural change. Nevertheless, David Rowe argues that relying on counter-cyclical capital buffers to neutralise the impact of pro-cyclical capital requirements is risky at best

Most of the discussion surrounding the pro-cyclical implications of risk-sensitive regulatory capital rules has focused on required capital. Naturally, however, few institutions hold just the bare minimum capital required by regulators. To do so would subject them to undesirable regulatory and market sanctions should an unexpected shock push their capital below the minimum. This raises the question of how capital buffers (the excess of actual capital over the minimum regulatory requirement)