over time and models need to take account of changes in default risk that are not purely related to the cycle. Lastly, there is a balance between granularity of measurement (data at the level of industry, portfolio, or segment based on risk drivers) and the availability of information.

Moreover, even though people generally agree on the need for smoothing capital requirement over the cycle, from the point of view of risk management and credit assessment, PIT estimates are more useful than TTC estimates, as they give more precise and up-to-date view of risk. Some may also argue that using TTC estimates would cause larger deviation of regulatory capital from a bank‘s economic capital as demanded by investors and counterparties, and weaken the effectiveness of Pillar 3 disclosure over time.<sup>44</sup> Adjustments to the regulatory capital calculation would need to take into account banks‘ internal risk management process and the supporting IT system. An option that has been proposed is to adjust the output of the Basel II formula (the minimum requirement) rather than the input (the PDs) using a multiplier based on deviation of GDP growth from its long-term trend, which would be more compatible with banks‘ existing risk pricing and risk management systems.<sup>45</sup> There are some studies on the procyclical impact of Basel II implementation in developing countries.<sup>46</sup> In addition to encouraging a long-term view of risk, one suggestion is to require banks to hold buffers<sup>47</sup> above the minimum requirement in good times. China, for example, adjusted minimum capital requirement based on supervisory discretion in 2009 in view of its rapid credit expansion. An additional 2 percentage points were added to the 8 percent minimum requirement for all banks, and another 1.5 percentage points were added for large banks. This looks similar to the countercyclical capital buffer to be discussed in the next section, but instead represents an adjustment to the minimum requirement. Compared to the earlier discussion on the adjustment of risk parameters, a simple adjustment may be more pragmatic for countries with data constraints and limited risk management capacity that may not be able to pursue more sophisticated approaches, although it may be less precise in calibration. However, the aforementioned challenges related to supervisory discretion, particularly the power and will to act, need to be considered under specific national circumstances.

# **4. Countercyclical Capital Buffer**

Beyond the aforementioned adjustments to the minimum requirement, a separate countercyclical capital buffer can be devised. This section focuses on the rules on the countercyclical capital buffer published by the Basel Committee on Banking Supervision (BCBS) in December 2010 as

> 44 See Gordy and Howells (2006).

> 45 See Repullo, Saurina, and Trucharte (2010).

> 46 See, for example, Segoviano and Lowe (2002); Griffith-Jones and Persaud (2006); and Kim and Lee (2006). 47 Although banks usually hold capital cushions in excess of the minimum requirement, which tend to mitigate the procyclicality of the minimum requirement, the cushions may not be sufficient to fully offset the impact of a crisis (especially under increasing market pressure, as actual capital level approaches the minimum), as is evident in the current crisis. Additional regulatory measures may be justified.

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