Fed Weighs New Tool to Ensure Credit

Central bank mulls change to bank capital requirements.

On Monday, the Wall Street Journal reported that the Federal Reserve board is considering a tool known as a countercyclical capital buffer.

Approved in 2016, the tool would allow the central bank to require large banks, typically those with more than $250 billion in assets, to increase their capital reserves when the economy shows signs of overheating. As the economy slows, that reserve would be allowed to shrink, freeing up more capital to lend out.

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  • Officials at the Fed are debating whether it’s time to use it—and how to use it. Some propose setting the tool now without increasing capital levels, while other Fed board members think higher capital requirements should first be implemented.

    The other concern is profitability for the big banks. Higher capital reserves could reduce their profitability now, and such profitability is already likely to decline as interest rates fall.

    Part of the severity of the Great Recession over a decade ago was the lack of credit at a time when it was needed. Such a tool could help reduce the possibility of another credit crunch.

    At present, there is also no explanation for how the Fed would induce consumers to borrow when they desire to pull back their lending activity, however.