Countercyclical Capital Buffers: A Cautionary Tale

Abstract

AbstractCountercyclical capital buffers (CCyBs) are an old idea recently resurrected. They compel systemically important banks to accumulate capital during expansions to sustain operations during downturns. We compare banks before the Great Depression, when CCyBs existed, and Great Recession, when they did not. Pre‐Depression systemically important banks built capital buffers between 3% and 5% of total assets during booms, nearly twice the maximum modern CCyB, while also reducing risky lending and building cash reserves. These buffers enabled banks at the core of the financial system to continue operations during severe crises while the rest of the financial system collapsed. This analogy indicates that modern countercyclical buffers may achieve their goals of protecting core banks during crises but raises questions about whether they will contribute to overall financial stability.