Macroprudential capital tools: assessing their rationale and effectiveness.

In this paper, the authors analyse the rationale for and effectiveness of macroprudential capital tools. They first present the limits of the traditional approach to bank capital regulation and the reasons why developing a more holistic approach is deemed appropriate. They then assess the effectiveness of capital tools (namely capital requirements, countercyclical capital buffers and sectoral risk weights) from a macroprudential perspective in the context of a dynamic general equilibrium model that features the default of the various classes of borrowers (banks, households and firms). Three main results stand out from this exercise: (i) there is generally an optimal level of capital requirements; (ii) the lower the banks’ capital ratio (or the higher their leverage), the greater the scope for amplification of real and financial shocks; (iii) a moderate degree of countercyclical adjustment of capital requirements may significantly improve the benefits of setting these requirements at a high level.