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The Day after Tomorrow
Regulatory reform should focus on the latter two sources of procyclicality.9 The thrust of reform in this area is the buildup of capital or liquidity buffers, or both, in good times, to cushion the adjustment in bad times. Two concrete proposals that have gained broad support are the use of procyclical capital requirements (Brunnermeier and others 2009), and procyclical bank provisioning.10 Under these proposals, capital requirements or provisions, or both, for loan losses would be scaled up or down according to cyclical conditions, such as measures of aggregate credit expansion, growth of gross domestic product, and so forth. At present, there is limited analytical research, and no actual experience, on the workings of procyclical capital requirements. In turn, procyclical provisioning has seen some actual use, notably in Spain and more recently in Peru and Colombia.11 There is consensus, especially in the case of Spain, that the provisioning scheme allowed banks to enter the downswing in more robust shape than they would have otherwise. However, there is much less evidence that countercyclical provisioning had any material effect on the credit cycle or that it helped in any significant way to contain Spain’s real estate bubble over the 2000s (Caprio 2010). Little is known about how the cycle should be measured for these purposes or what degree of cyclical sensitivity regulations should have. The same applies to other measures that have seen some limited application, such as countercyclical loan-to-value ratios and direct controls on specific credit flows—for example, mortgages or consumer credit—that have been employed by emerging markets in Asia (Caruana 2010). The extent to which they have been effective in mitigating credit and asset price booms remains an open question. These reforms will tend to complicate the task of regulators and supervisors, and place additional burdens on their capacity. Moreover, experience shows that procyclical tightening of prudential regulation will encourage disintermediation12 to less-regulated institutions (or countries), limiting its effectiveness. Finally, the political economy challenges should not be ignored. Attempts by the authorities to rein in credit expansion in good times, in the absence of obvious symptoms of inflationary or financial distress, will meet strong resistance from both lenders and borrowers riding the boom and from policy makers crediting the boom to their good policies. The reliance of regulators on well-defined rules (rather than discretionary regulatory changes) and independence