30 SECOND GUIDE TO ...
COUNTER CYCLICAL CAPITAL BUFFERS
That’s a mouthful. What is it? IT REQUIRES firms to bolster their financial defences either by issuing shares or retaining earnings as a cushion against risks building in the system.
It is no more tricky than the concept of making hay while the sun is shining. Why do banks do this? Before the financial crisis, banks were lending liberally without enough capital to cover their losses. But in times of downturn, banks restrict lending, which means businesses struggle to borrow and so the economy is driven down even further.
Maintaining a healthy amount of capital enables banks to absorb losses during a downturn, which is why they are now being asked to build up these buffers. Who makes the banks do this? The rules were agreed by the Basel Committee, which is a global body that sets standards for the safety and soundness of banks. These standards have been implemented under European Union law.
Since May 2014, the Financial Policy Committee has had the responsibility to set the counter cyclical capital buffers in the United Kingdom. How does it work? If the counter cyclical capital buffer is lifted, banks are given 12 months to meet it
If economic conditions indicate that a smaller capital buffer is needed, banks can reduce it straight away.