United States: Bubble, Bubble Toil And Trouble: The Fed Breathes Life Into The Countercyclical Capital Buffer

Widespread problems in the banking system are often associated with sharp declines in asset prices, or the economy more broadly. When these declines result in loan defaults, bank capital can erode, leading to more stringent underwriting standards, tighter credit and further declines in economic activity. In theory, a capital cushion that can be reduced in times of stress while still maintaining adequate capital levels in banking institutions might be used to mitigate this cycle. Capital could be increased during times of irrational exuberance and then reduced as the bubble bursts and losses accrue. This theory was incorporated into section 616 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which provides that

[i]n establishing capital regulations pursuant to [the Bank Holding Company Act of 1956], the [Federal Reserve Board] shall seek to make such requirements countercyclical, so that the amount of capital required to be maintained by a company increases in times of economic expansion and decreases in times of economic contraction, consistent with the safety and soundness of the company.1

In practice, the idea of countercyclical capital raises issues of correctly identifying market conditions that are likely to lead to eventual contractions and communicating those determinations in a way that do not make them self-fulfilling prophecies. Accordingly, implementing countercyclical capital will entail a lot of hard work in monitoring economic activity and a certain amount of risk.

With these issues in mind, on December 21, 2015, the Board of Governors of the Federal Reserve System (the "Federal Reserve"), in consultation with the Federal Deposit Insurance Corporation (the "FDIC") and the Office of the Comptroller of the Currency (the "OCC" and, together with the Federal Reserve and FDIC, the "Banking Agencies"), announced that it was seeking public comment on a proposed policy statement (the "Policy Statement") that details the framework that the Federal Reserve will follow in establishing the U.S. Basel III countercyclical capital buffer ("CCyB") for large, internationally active banking organizations that are subject to the advanced approaches capital rules (referred to herein as "Advanced Approaches Institutions"). Such banking organizations generally include (1) all financial institutions with greater than $250 billion in total assets or $10 billion in on-balance-sheet foreign exposure, and (2) any depository institution subsidiary of such a banking organization. 2

The CCyB is intended to be a macroprudential tool that the Federal Reserve may use to strengthen the financial system by raising capital requirements when there is an elevated risk of above-normal losses. The CCyB functions as an extension of the Capital Conservation Buffer and, from a regulatory standpoint, is already provided for in the regulatory capital rules ("Regulation Q") issued in June 2013 by the Federal Reserve, in coordination with the FDIC and OCC. 3 While the capital rules detail the mechanics of applying the CCyB, the Policy Statement focuses on when the CCyB will be invoked.

The Policy Statement, which is described in greater detail below, consists of six sections that together enunciate the framework that the Federal Reserve will follow in determining the appropriate CCyB for U.S.-based credit exposure. 4

In addition to issuing the Policy Statement for comment, the Federal Reserve also voted to affirm the CCyB amount at the level of zero percent. Once fully phased in, the CCyB, which is calculated based on private-sector credit exposures located in the United States, will range anywhere from zero percent of risk-weighted assets (indicating moderate financial-system vulnerabilities) to a maximum of 2.5 percent (denoting significantly elevated financial-system vulnerabilities). If the Federal Reserve decides to increase the CCyB amount, Advanced Approaches Institutions would have 12 months to comply with the increased CCyB amount before it becomes effective (unless the Federal Reserve expressly establishes an earlier effective date). The Federal Reserve has set a deadline for comments to the Policy Statement on or before February 19, 2016.

Section 1. General Background of the Policy Statement. As described in Section 1 of the Policy Statement, the CCyB is a flexible macroprudential policy tool that the Federal Reserve can increase during times of stress on the financial system and reduce when vulnerabilities of the stability of the financial system subside. The primary goal of the CCyB is to augment the resiliency of large banking organizations when there is an elevated risk of above-normal losses, which, in turn, should serve to enhance the strength of the financial system generally. Above-normal losses frequently follow periods of rapid asset price appreciation or credit growth that are not well supported by underlying economic fundamentals.

Section 1 further explains that the Federal Reserve, working jointly with the OCC and FDIC, will set the CCyB moving forward by taking into account the macrofinancial environment in which banking organizations function and the degree to which that environment impacts the resilience of the group of Advanced Approaches Institutions. However, in practice, the CCyB will fluctuate for each Advanced Approaches Institution, given that the CCyB is weighted based on a banking organization's particular composition of private-sector credit exposures across national jurisdictions.

Section 2. Overview and Scope. Section 2 sets forth the scope of the Policy Statement. Specifically, the Policy Statement provides the Federal Reserve with a framework to set the amount of the CCyB for U.S.-based credit exposures. This framework: (i) provides a set of principles for translating assessments of threats to the stability of the financial system into the appropriate level of the CCyB; and (ii) assesses whether the CCyB is the most appropriate policy instrument to address particular financial-system vulnerabilities.

Section 3. Objectives of the CCyB. Section 3 outlines the objectives of the CCyB: (i) strengthening of banking organizations' resiliency against the build-up of systemic vulnerabilities; and (ii) reduction of fluctuations in the supply of credit. While prior rules implemented by the Banking Agencies, such as the minimum capital requirements, the capital conservation buffer and the capital surcharge (imposed on global systemically important banking organizations, or "G-SIBs"), have sought to provide greater market resiliency to unexpected losses and financial distress, banking organizations are still susceptible to undercapitalization during periods of financial excesses, as reflected by bouts of rapid asset appreciation or credit growth not well supported by underlying economic fundamentals, followed by above-normal losses.

Accordingly, the Federal Reserve expects that the CCyB will help to achieve greater market resiliency for Advanced Approaches Institutions, as well as the financial market at large, in the following two ways. First, Advanced Approaches Institutions will likely hold more capital to avoid limitations on capital distributions and discretionary bonus payments resulting from the implementation of the CCyB. Second, the CCyB will help promote a more sustainable supply of credit over the economic cycle. If Advanced Approaches Institutions are better capitalized, they will likely have continued access to funding and be less likely to take actions that create broader financial-sector distress and associated macroeconomic costs. Accordingly, as a result of the CCyB being put into place during a period of rapid credit creation, such Advanced Approaches Institutions will likely be better positioned to continue their important intermediary functions even during a subsequent market downturn. Furthermore, Advanced Approaches Institutions might react to an increase in the CCyB by tightening lending standards, increasing capital, or both. Such actions will only further reduce the likelihood that Advanced Approaches Institutions with insufficient capital would need to engage in imprudent risk taking.

Section 4. The Framework for Setting the U.S. CCyB. Section 4 lists the factors that the Federal Reserve intends to consider when determining the appropriate size of the U.S. CCyB, including: (a) financial-system vulnerabilities; (b) financial and macroeconomic quantitative indicators; and (c) relevant empirical models.

First, the Federal Reserve will evaluate financial-system vulnerabilities, including, but not limited to: (i) asset valuation pressures and risk appetites; (ii) leverage in the nonfinancial sector; (iii) leverage in the financial sector; and (iv) maturity and liquidity transformation in the financial sector. Any decision regarding the appropriateness of the U.S. CCyB will reflect the implications of the assessment of the aforementioned financial-system vulnerabilities, as well as any concerns related to certain classes of vulnerabilities.

Second, the Federal Reserve will monitor a wide range of financial and macroeconomic quantitative indicators, including, but not limited to: (i) measures of relative credit and liquidity expansion or contraction; (ii) a variety of asset prices; (iii) funding spreads; (iv) credit condition surveys; (v) indices based on credit default swap spreads; (vi) options implied volatility; and (vii) measures of systemic risk. 5

Third, the Federal Reserve will also take into consideration empirical models that translate a manageable set of quantitative indicators of financial and economic performance into potential settings for the CCyB. Such models may include: (i) those that rely on small sets of indicators (e.g., credit-to-GDP ratio, its growth rate and a combination of the credit-to-GDP ratio with trends in the prices of residential and commercial real estate); and (ii) those that consider larger sets of indicators, which have the advantage of representing conditions in all key sectors of the economy (such as those specific to risk-taking, performance and the financial condition of larger banks).

When setting the CCyB, the Federal Reserve will nevertheless consult with the OCC and FDIC on their analyses of what constitutes financial-system vulnerabilities and the extent to which banking organizations are exposed to or contributing to such vulnerabilities.

Based on its analysis of these factors, the Federal Reserve will then set the CCyB on a sliding scale, ranging from zero percent to 2.5 percent. A zero percent U.S. CCyB amount would indicate the Federal Reserve's view that U.S. economic and financial conditions are generally consistent with a financial system in which levels of system-wide vulnerabilities are not "somewhat above normal." Conversely, increasing the CCyB to 2.5 percent for U.S.-based credit exposures would reflect the Federal Reserve's determination that the U.S. financial sector is undergoing a period of significantly elevated or rapidly increasing system-wide market vulnerabilities. As a macroprudential tool, the CCyB will be adjusted based on the developments and trends in the U.S. financial system as a whole, as opposed to the "micro" activities of any individual banking organization. Therefore, when certain market vulnerabilities causing the increase of the CCyB have diminished, the Federal Reserve will remove or reduce the CCyB in a timely manner. However, the pace at which the CCyB will be raised or lowered will greatly depend on the financial sector's underlying conditions, the general economy and desired effects of the proposed changes in the CCyB.

While the Federal Reserve notes in Section 4 that it will consider the aforementioned indicators and models when determining the appropriate level of the CCyB for U.S.-based credit exposures, it cautions that no single indicator or fixed set of indicators can comprehensively capture all the key vulnerabilities in the U.S. economy and financial system. The Federal Reserve further states that tightly linking adjustments in the CCyB to a specific model or set of models would be imprecise due to the relatively short period that some indicators are available, the limited number of past crises against which the models can be calibrated and the Federal Reserve's limited experience with the CCyB as a macroprudential tool. Accordingly, the indicators and models used to determine the appropriate level of the CCyB will not be static, but instead constantly evolving based on research and as the Federal Reserve becomes more comfortable using and evaluating the CCyB tool.

Finally, as explained in Section 4, it is also possible that the CCyB will be an inappropriate policy instrument to utilize at times, depending on the type of financial-system vulnerability. For example, structural vulnerabilities are likely better addressed through targeted reforms or permanent increases in financial system resiliency, as opposed to the CCyB, which is intended to address cyclical vulnerabilities.

The criteria laid out in Section 4 provide for wide discretion in invoking the CCyB and enable the Federal Reserve to consider other macroprudential tools, which may include more conventional monetary policy tools.

Section 5. Communication of the U.S. CCyB with the Public. Section 5 of the Policy Statement sets forth the frequency with which the Federal Reserve plans to evaluate the appropriate level of the U.S. CCyB, as well as the ways in which the Federal Reserve intends to communicate its assessment of the financial stability of the U.S. markets to the public.

The Federal Reserve notes in Section 5 that it will review financial conditions regularly throughout the year, and expects to consider the applicable level of the U.S. CCyB at least annually. However, the Federal Reserve may adjust the CCyB depending on the results of its monitoring activities.

Furthermore, the Federal Reserve will communicate regularly with the public regarding its assessment of U.S. financial stability, including financial-system vulnerabilities. The Federal Reserve will continue to provide an update on developments pertaining to the stability of the U.S. financial system in its biannual Monetary Policy Report to the U.S. Congress. Specifically, the Federal Reserve will utilize the Monetary Policy Report to update the public on how the Federal Reserve's current assessment of financial-system vulnerabilities bears on the setting of the level of the CCyB.

Section 6. Monitoring of the Effects of the U.S. CCyB. As the Federal Reserve outlines in Section 6 of the Policy Statement, the effects of the U.S. CCyB on the broader financial system will largely depend upon a complex set of interactions between required capital levels at the largest banking organizations, and the economy and financial markets. It is also possible that secondary economic effects could result if the financial markets associate changes to the CCyB value with subsequent actions that the Federal Reserve plans to take.

In order to gain a better understanding of the direct and indirect effects associated with the U.S. CCyB, the Federal Reserve intends to monitor and analyze adjustments by banking organizations and other financial institutions to the CCyB. The results of these monitoring efforts could cause the Federal Reserve to favor either a higher or a lower value of the CCyB.

As provided in Section 6, the Federal Reserve will monitor for several potential consequences resulting from changes to the CCyB, including, but not limited to:

  • Whether changes in the CCyB result in changes to risk-based capital ratios at Advanced Approaches Institutions, and whether such changes are achieved passively through retained earnings, or actively through changes in capital distributions or in risk-weighted assets;
  • The extent to which loan growth and spreads on loans issued by Advanced Approaches Institutions change relative to loan growth and loan spreads at banking organizations not subject to the CCyB; and
  • The extent to which adjustments by Advanced Approaches Institutions to higher capital buffers lead to the migration of credit market activity outside of those banking organizations, such as to the non banking financial sector.

The Federal Reserve further notes that it will also consider the levels of and changes in the CCyB in other countries in order to garner a greater understanding of the effects of changes in the CCyB. The Federal Reserve will evaluate the data maintained and made publicly available on the Basel Committee on Banking Supervision website, as well as other supervisory and publicly available data sets.


1 The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, Sec. 616 (July 21, 2010). Similar provisions apply to savings and loan holding companies and insured depository institutions.

2 See 12 C.F.R. § 217.100(b)(1).  

3 See Regulatory Capital Rules, 78 Fed. Reg. 62018 (Oct. 11, 2013) (Federal Reserve and OCC); Regulatory Capital Rules, 79 Fed. Reg. 20754 (Apr. 14, 2014) (FDIC). Regulation Q applies generally to all bank holding companies with greater than $1 billion in total consolidated assets and savings and loan holding companies with more than $1 billion in total consolidated assets that are not substantially engaged in commercial or insurance underwriting activities. See 12 C.F.R. § 217.1(c)(1).

4 The CCyB is subject to a phase-in arrangement between 2016 and 2019. See 12 C.F.R. § 217.300(a)(2). 

5 See 12 C.F.R. § 217.11(b)(2)(iv). 

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.