Countercyclical capital regime revisited: Tests of robustness

Financial entities have been subject to risk-based capital requirements for many years. The experiences of the recent financial crisis led to heightened criticism that these rules are pro-cyclical, meaning they require insufficient capital during economic booms and excessive capital during busts. In response, recent revisions to such rules have included a countercyclical capital buffer, but it is problematic because implementation is discretionary with respect to both timing and amount on the part of regulators. An alternative rules-based countercyclical capital proposal put forth by Smith and Weiher (April, 2012. Countercyclical capital regime: a proposed design and empirical evaluation. Federal housing finance agency, working paper no. 12-2) that embodies a dynamically adjusting stress test for mortgage assets was intentionally structured to address these concerns.