This is based on the observable facts that arrears and defaults tend to emerge in downturns and that loans written at the top of the cycle tend to have higher losses. Banks are required therefore to set aside a general provision against likely future loss each time they write a loan on the basis of a formula which is sensitive to the cycle. This is an accounting provision so these provisions are deducted from profits when they are made, and reduce dividends and profit related bonuses. They are then drawn down automatically as losses appear. In effect this requires banks to build up reserves in the upswing of a cycle which can cushion their losses in the downswing. The system has not prevented a property boom and bust in Spain but it has put their banks in a much stronger position to survive it by calling on these general provisions which amounted to over 1% of total assets. And in the process of protecting the banks from the cycle, this system has helped to some degree to dampen the cycle itself. Varying capital regulations in this way can act as a brake on the exuberant swings in lending we have seen in recent years. By requiring banks to hoard capital in the upswing, regulators make it more expensive for banks to lend money. And by dampening the credit cycle policy could help stabilise spending in the real economy.
4 Daniel Awrey and David Kershaw, “Toward a More Ethical Culture in Finance: Regulatory and Governance  Strategies,” in Nicholas Morris and David Vines, eds., Capital Failure: Rebuilding Trust in Financial Services, 284 (2014) (“While codes of conduct, ethics, and best practice can be drafted and held up as identifying desirable behaviors, the norms these codes purport to reflect may be overpowered by other countervailing influences.”). 5 Mark Egan, Gregor Matvos, and Amit Seru, “The Market for Financial Advisor Misconduct,” Working Paper 22050,  National Bureau of Economic Research, February 2016. 6 Gillian Tett, The Silo Effect, 45 (2016). 7 Ignazio Angeloni, Ethics in finance: a banking supervisory perspective, Remarks at the Conference on “The New  Financial Regulatory System: Challenges and Consequences for the Financial Sector,” September 26, 2014. 8 David Walker, Trust and Trustworthiness in Banks and Bankers, Remarks at the Federal Reserve Bank of New  York, October 20, 2014. 3/3  BIS central bankers' speeches