DP19790 The Positive Neutral Countercyclical Capital Buffer
We build a quantitative macro-banking model to study the optimal setting of the counter-cyclical capital buffer (CCyB) over the cycle. The model provides a rationale for micro and macro-prudential capital regulations by allowing for empirically-relevant bank default risk and binding borrowing constraints faced by banks and firms. We find that over-the-cycle adjustments in the CCyB can induce significant stabilization and welfare gains. Such gains: (i) are the largest if the CCyB is built in response to expected upward shifts in the bank lending spread, and (ii) increase with aggregate economic volatility and with the share of firms whose borrowing capacity is tied to their property collateral (rather than to their earnings). The calibrated optimal positive neutral CCyB for the case of the euro area lies between 1.8% and 2.5%.
