Countercyclical Capital Buffers: A Cautionary Tale

50 Pages Posted: 3 Feb 2020 Last revised: 26 Jun 2022

See all articles by Christoffer Koch

Christoffer Koch

Federal Reserve Bank of Dallas

Gary Richardson

University of California, Irvine - Department of Economics

Patrick Van Horn

Scripps College

Date Written: January 2020

Abstract

Countercyclical capital buffers (CCyBs) are an old idea recently resurrected. CCyBs compel banks at the core of financial systems to accumulate capital during expansions so that they are better able to sustain operations during downturns. To gauge the potential impact of modern CCyBs, we compare the behavior of large and highly-connected commercial banks during booms before the Great Depression and Great Recession. Before the former, core banks did not expect bailouts and were subject to regulations that incentivized capital accumulation during booms. Before the later, core banks expected bailouts and kept capital levels close to regulatory minima. Our analysis indicates that the pre-Depression regulatory regime induced money-center banks to build capital buffers between 3% and 5% of total assets during economic expansions, which is up to double the maximum modern CCyB. These buffers enabled those banks to continue operations without government assistance during severe crises. This historical analogy indicates that modern countercyclical buffers may achieve their immediate goals of protecting core banks during crises but raises questions about whether they will contribute to overall financial stability.

Suggested Citation

Koch, Christoffer and Richardson, Gary and Van Horn, Patrick, Countercyclical Capital Buffers: A Cautionary Tale (January 2020). NBER Working Paper No. w26710, Available at SSRN: https://ssrn.com/abstract=3530681

Christoffer Koch (Contact Author)

Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX Texas 75265-5906
United States

HOME PAGE: http://www.dallasfed.org

Gary Richardson

University of California, Irvine - Department of Economics ( email )

3151 Social Science Plaza
Irvine, CA 92697-5100
United States

Patrick Van Horn

Scripps College ( email )

Claremont, CA 91711
United States

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