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 Topics
Related Articles
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions