Cyprus and International, Economic Analysis

Actions for a less Procyclical Financial System

Actions for a less Procyclical Financial System
Author: Gikas A. Hardouvelis
Publication: Economy & Markets, Volume 5, Issue 5, September 2010


  • Even though economic cycles are partly caused by what economists call “deep” parameters of economic behavior, financial sector behavior can exacerbate the amplitude of fluctuations in economic activity and subsequently those larger fluctuations can feed back to a more extreme behavior of the financial sector, creating a phenomenon of mutual procyclicality.
  • Economic policies intended to counteract procyclicality cannot be purely financial or economic, but mixed and their importance became apparent in the aftermath of the 2007-2008 global financial and economic crisis.
  • Twenty different factors contributing to procyclicality are analyzed, after being categorized into four groups: Economic, financial, policyrelated and institutional. The instruments to confront those factors are correspondingly many: capital requirements, provisioning, collateral and margin requirements, leverage and liquidity ratios, accounting methods, micro-structure issues and other.
  • Countercyclical regulatory policies are related to a number of problematic aspects of the global financial system: the “too big to fail or save” financial institution problem, the “short-termism” in the behavior of managers, market microstructure, contagion between apparently unrelated financial markets, or measurement of market risk.
  • The G-20 have agreed on a stricter definition of capital and higher capital requirements, with buffers which have countercyclical features. They also agreed to impose restrictions on financial institutions’ liquidity and leverage.
  • Provisioning has also occupied the public debate without any concrete proposals up to now, collateral and margin requirements are rather ignored, while accounting methods are not being discussed to the degree needed.
  • Yet, for effective regulation, it is prudent to utilize all available instruments, and not rely almost exclusively on a few prominent ones. The multiplicity of policy targets – regulatory, monetary, fiscal and other – necessitates a multiplicity of policy instruments, each of which ought to take into consideration the impact of the others as well as their mutual complementarity.
  • Issues of instrument comprehensiveness, timing and cost are also very important in the design of an effective regulatory system that would safeguard stability and promote financial intermediation.

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