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IAI Actuarial Core Principles · Business Economics · Role, structure and stability of the financial system

A regulator introduces a countercyclical capital buffer, raising capital requirements when credit growth is excessive and relaxing them in downturns. Which statement best explains its macroeconomic rationale?

The countercyclical buffer reduces procyclicality: higher requirements in credit booms restrain excess lending and build resilience, while releasing the buffer in downturns lets banks keep lending instead of shrinking balance sheets. It is a macroprudential stabiliser, not a permanent lending boost or a substitute for monetary policy.

  1. AIt leans against the financial cycle, curbing lending in booms and leaving banks capacity to keep lending in downturns, which reduces procyclicalityCorrect
  2. BIt permanently raises banks' lending in all phases of the cycle to boost growth
  3. CIt replaces the need for any monetary policy by fixing the exchange rate
  4. DIt is designed mainly to raise banks' dividend payouts in recessions
  5. It transfers all bank losses to the central bank during booms

Explanation

Fixed capital rules tend to force banks to cut lending in downturns, deepening recessions, and allow excessive lending in booms. A buffer built in good times and released in bad times offsets this procyclicality. It does not permanently raise lending, fix exchange rates or fund dividends.

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