Working Paper: NBER ID: w26710
Authors: Christoffer Koch; Gary Richardson; Patrick Van Horn
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.
Keywords: Countercyclical Capital Buffers; Financial Stability; Bank Regulation; Great Depression; Great Recession
JEL Codes: E02; E42; G01; G2; G21; G3; N1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Pre-Depression regulatory regime (G18) | Capital accumulation behavior of banks (E22) |
| Expectations of government bailouts (H81) | Capital accumulation behavior of banks (E22) |
| Regulatory environment (G38) | Capital choices of banks (G21) |
| Capital ratios and leverage patterns (G32) | Capital accumulation behavior of banks (E22) |
| Modern CCYBs (E19) | Financial instability (F65) |