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Automatic cycle-stabilising capital requirements - what can be achieved?

Tim Ng

This paper discusses the potential for lenders’ capital requirements to be used as ‘automatic stabilisers’ of the business cycle in New Zealand. The procyclicality of lending, and its importance for cyclical developments, motivates the consideration of regulation of lending for cycle-stabilisation purposes. This application of lenders’ capital requirements is distinct from, but complements, the prudential reasons for capital adequacy requirements. I set out a putative capital requirement on housing lending intended to have cycle-stabilising properties. I explore the likely degree of cycle stabilisation that could be expected from feasible calibrations of such a requirement. I conclude that the putative cycle-stabilising capital requirement might have some impact on the cycle at the margin, and that this impact is most likely on the downside of cycles. However, the highly developed and open nature of New Zealand’s housing lending markets is likely to limit the degree of cycle stabilisation that can be achieved with this approach.