And this positive impact is such that it, in turn, boosts credit demand and banks’ income, which ultimately translates into higher solvency levels. In any event, it is important to note that it may be difficult for banks to use buffers if they fear they may be penalised by the financial markets for reaching certain capital ratios, which would increase their funding costs and could, therefore, affect their solvency levels. This  3  market stigma effect could lead banks to avoid using capital buffers, which in accordance with the above analysis would have a negative impact on the economy.1 In addition, the use of these capital buffers may be more difficult if there are doubts about how they will be rebuilt post-crisis. The difficulty would be if banks were obliged to rebuild the buffers at a time when their capacity to generate profit was only modest or when the market might not be very receptive. In this setting, clear communication by the macroprudential and microprudential authorities on the capacity to make use of these buffers and on the flexibility as to how they are subsequently rebuilt is essential. In this respect, the authorities have made it very clear that banks will have sufficient time to resume compliance with the capital requirements, and that the rebuilding process will not in any event begin until the main effects of the pandemic have been dispelled.
The Basel reforms that were phased in over the last decade incorporated into regulations the lessons learned during the global financial crisis. The first stage of the Basel reforms began in 2010 and concluded with a second wave of reforms published in 2017. In the first phase, the aim was to boost the level and the quality of banks’ microprudential capital requirements. The intention was to reduce their risk-taking, by increasing their “skin in the game”, and to provide them with greater loss-absorbing capacity. In addition, the releasable macroprudential buffers I referred to earlier were also introduced. The second phase of the Basel reforms focused on a matter that came to light during the first phase, namely the calculation of risk-weighted assets (the denominator of the capital requirements under the Basel standards) and the need to standardise their treatment among institutions. Once again, the aim was to reinforce banks’ credibility with regard to their prudential ratios and the correct measurement of the risks they assume. A crucial aspect of this reform is the “output floor”, which limits the reductions that banks can obtain by using internal models to calculate minimum capital requirements instead of the standardised approach that does not require the use of models and is much less sensitive to new data inputs. 5  The impact analyses of the reform reveal that banks’ capital requirements would increase in some jurisdictions, although they would also be reduced by certain elements.