DP8304 The Countercyclical Capital Buffer of Basel III: A Critical Assessment

Author(s): Rafael Repullo, Jesús Saurina
Publication Date: March 2011
Keyword(s): Bank capital regulation, Basel III, Business cycles, Credit crunch, Pro-cyclicality
JEL(s): E32, G28
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8304

We provide a critical assessment of the countercyclical capital buffer in the new regulatory framework known as Basel III, which is based on the deviation of the credit-to-GDP ratio with respect to its trend. We argue that a mechanical application of the buffer would tend to reduce capital requirements when GDP growth is high and increase them when GDP growth is low, so it may end up exacerbating the inherent pro-cyclicality of risk-sensitive bank capital regulation. We also note that Basel III does not address pro-cyclicality in any other way. We propose a fully rule-based smoothing of minimum capital requirements based on GDP growth.