A second question is, How we can structure these requirements and other aspects of regulation to damp, rather than reinforce, the natural procyclical tendencies of the financial system? Among the challenges will be encouraging firms and supervisors to comfortably allow buffers to be eroded in bad times.
Interestingly, prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act of 1991 was intended, in part, to induce an element of countercyclical behavior by banks. It gives banks an incentive to build excess capital – on both a risk-based and leverage ratio basis – in good times to avoid prompt corrective action when circumstances are less favorable.