Conclusion A final word about short-run-long-run tradeoffs. Some have argued that both risk-sensitive capital charges and market discipline will be pro-cyclical. The rationale, as I understand it, is that following a peak, as economic conditions deteriorate, evaluations of risk will change, and risk premiums will rise.
As more potential borrowers are viewed as riskier, banks will be even less willing to lend so as to avoid facing higher capital charges or higher borrowing costs or less availability in the market. In an improving economy, the opposite occurs. As one of my colleagues states, the problem with market discipline and risk-based capital is that they work.