Procyclicality has emerged as a potential drawback to adoption of risk-sensitive bank capital requirements. Systematic risk factors may result in increases (decreases) in bank capital requirements when the economy is depressed (overheated), thereby decreasing (increasing) bank lending capacity and exacerbating business cycle fluctuations. Procyclicality may result from systematic risk emanating from common macroeconomic influences or from interdependencies across firms as financial markets and institutions consolidate internationally. We survey the literature on cyclical effects on operational risk, credit risk and market risk measures.
This document is published in Journal of Financial Services Research (volume 26, number 4) October 2004, 161-191.
http://dx.doi.org/10.1023/B:FINA.0000037545.38154.8a