Procyclicality

1. Bank supervision - capital adequacy - leverage.

The tendency of financial systems to amplify fluctuations in the economic cycle.

Interaction and amplification

"Herd behaviour has long been known to be an essential feature of financial markets.

More subtly, individual reactions, by themselves rational, can, by the virtue of their mutual interaction, produce strong amplification effects.

A broader definition of procyclicality would thus encompass three components, which cannot easily be distinguished in real life:

(1) fluctuations around the trend

(2) changes in the trend itself and

(3) possible cumulative deviations from equilibrium value.

This points to the policy challenges regulators face.

They have to try and identify when pure cyclical fluctuations morph into something different: either a change in the trend itself or the start of a cumulative process...

One major source of procyclicality is excessive risk taking. Bubbles develop because investors have an incentive to ignore the "tail risk" that the bubble may burst.

Because bubbles are mostly financed by credit, most of the risk is shifted to lenders. This asymmetry in incentives is extremely difficult to eliminate [in advance].

Hence the need, for macroprudential supervisors, to monitor closely the financial system and preserve their possibility to intervene..."

Jean-Pierre Landau, Deputy Governor of the Bank of France, BIS Review 94/2009.

2. Bank supervision - capital adequacy - leverage - risk management.

The degree to which a particular financial institution is at risk from the effects of procyclical fluctuations, directly or indirectly.

3. Risk - risk management.

Similar effects in non-financial sectors of the economy, or the degree of risk to which a particular non-financial organisation is exposed to procyclical risks.

See also

• Bank
• Bank supervision
• Basel III
• Bubble
• Buffer
• Capital
• Capital adequacy
• Capital buffer
• Conservative
• Countercyclical
• Countercyclical buffer
• Credit
• Cumulative
• Cyclical
• Deviation
• Economy
• Equilibrium
• Herd behaviour
• Leverage
• Macroprudential
• Procyclical
• Procyclical risk
• Prudential
• Regulator
• Resilience
• Risk
• Risk management
• Supervision
• Tail risk
• Total Loss Absorbing Capacity (TLAC)
• Trend

Other resource

• Procyclicality - what it means and what could be done - Jean-Pierre Landau, Deputy Governor of the Bank of France, BIS Review 94/2009