Procyclicality

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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."


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


See also