Procyclicality

By THIS IS MONEY
Updated:

 

The Daily Mail city team explains what the term procyclicality means.

What is it?

International rules have encouraged banks to act more aggressively when the economic cycle is in the middle of an upswing, when some argue that is precisely when they should be putting money away for a rainy day. The global economy has become more volatile as a result.

How do the rules work?

Banks must keep an adequate cash cushion to avoid going belly up.

But under the current Basel II rules, they have to keep less money to hand when the economy is growing, while stashing away more during lean periods.

What's the problem?

The regulations have made the credit crunch much more severe than it needed to be. If banks had been forced to hoard more capital over recent boom years, they would have been able to keep lending to businesses and consumers. Instead, banks are having to rein in, putting the broader economy under severe strain.

Why do I care?

International regulators in Basel have twigged that the rules need changing. In the future banks will have to build bigger buffers to cover investments in complex mortgage-backed assets.

More money will also have to be set aside for 'prolonged' droughts in the wholesale money markets. Sounds like shutting the stable door after the horse has bolted.

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