Measures Aimed at Mitigating Pro Cyclical Effects of the Capital Requirements Framework: Counter Cyclical Capital Buffer Proposals

Abstract

As well as highlighting the importance of introducing counter cyclical capital buffers, this paper draws attention to the need for greater focus on “more forward looking provisions”, as well as provisions which are aimed at addressing losses and unforeseen problems attributed to “maturity transformation of short-term deposits into long term loans.” Whilst the need for forward looking provisioning has been echoed by some authorities on the literature, the paper also adds weight to the argument through its attempt to link such an argument to the ever increasing prominence assumed by liquidity risks - since liquidity also contributes to pro cyclicality.

“The complex response of financial institutions to deteriorating market conditions - which to a large extent, is attributed to liquidity shortfalls which reflected on and off balance sheet maturity mismatches and excessive levels of leverage, has resulted in an increasingly important role for liquidity provided by central banks in the funding of bank balance sheets.” Owing to such increased importance of liquidity risks, this paper also attempts to highlight why the Basel Committee’s Counter Cyclical Buffer Proposal - a response to the recent financial crisis (which to a significant extent, focuses on banking sector capital requirements), should also take greater account of more forward looking provisions. In so doing, it draws attention to the importance of coupling forward looking provisions (as well as other measures) with counter cyclical charges and why this provides a better alternative to the mere introduction of counter cyclical capital charges.

Keywords: Counter cyclical buffers, liquidity risks, pro cyclicality, capital, loan loss provisions, financial crises, bank, regulation