This note sets out recommendations to address the potential procyclicality of the regulatory capital framework for internationally active banks. Some of these recommendations are focused on mitigating the cyclicality of the minimum capital requirement, while maintaining an appropriate degree of risk sensitivity. Other measures are intended to introduce countercyclical elements into the framework.

The recommendations on procyclicality form a critical part of a comprehensive strategy to address the lessons of the crisis as they relate to the regulation, supervision and risk management of internationally active banks. This strategy covers the following four areas:

  • Enhancing the risk coverage of the Basel II framework;
  • Strengthening over time the level, quality, consistency and transparency of the regulatory capital base;
  • Mitigating the procyclicality of regulatory capital requirements and promoting the build up of capital buffers above the minimum in good economic conditions that can be drawn upon in stress; and
  • Supplementing the capital framework with a simple, non-risk based measure to contain the build up of leverage in the banking system.

The objective of these measures is to ensure that the Basel II capital framework promotes prudent capital buffers over the credit cycle and to mitigate the risk that the regulatory capital framework amplifies shocks between the financial and real sectors. As regulatory capital requirements are just one driver of bank lending behaviour, the proposals set out should be considered in the wider context of other measures to address procyclicality and reduce systemic risk.

The Basel Committee will elaborate on the recommendations over the course of 2009, and will develop a final package of proposals by the end of 2009. It should then assess the impact of the proposals on banks’ capital requirements and whether further adjustments are needed.

Any implementation of new capital-related measures will be carried out in a manner that does not aggravate the current economic and financial stress. (On this matter, also refer to the Basel Committee’s press release of 12 March 2009.) Continue reading