Approach 3 – banks’ ‘headroom’ over their regulatory requirements A third way to approach the question of buffer usability is through the concept of ‘headroom’, that is the surplus a bank has over its regulatory buffers. Firms entered the crisis with varying amounts of headroom. So a key question is whether those that had less headroom ahead of the pandemic tended to lend less than their peers through the crisis. If they did, that could signal a strong desire not to use capital to support lending, likely because of fears about the consequences of breaching the regulatory buffer. If this was the case, then it would suggest that non-releasable regulatory buffers are not practically usable. The Basel Committee’s work on this includes an empirical analysis of this question. This work evaluates the link between headroom and lending across more than 200 banks.17 It shows a positive and significant relationship: banks with larger headroom to total (public) regulatory buffers tended to lend more than those that were closer to their regulatory buffers. In addition, the ECB has published analysis that evaluates the link between headroom and lending across banks under their supervision.18 It shows that firms’ lending and capital management choices varied during the pandemic based on their proximity to their buffer requirements. With their granular data, the ECB were also able to show that this remained the case when controlling for credit demand from borrowers. In particular, banks with less headroom to regulatory requirements lent less to non-financial companies in the euro area during the pandemic.

Authorities have been tested and have established more effective mechanisms for addressing problem bank situations. Financial institutions have undertaken a range of measures themselves to improve risk management practices, operational controls, and core profitability. Some institutions have attempted to comply with international standards, notwithstanding lower domestic requirements. These reforms are especially important in light of the fact that the obligation to promote financial soundness rests mainly with financial institutions themselves. Taken together, these reforms indicate progress toward reduced systemic risk, heightened competition, increased banking services provided to the domestic population, and higher standards of conduct better approximating international standards. Work Ahead Notwithstanding this progress, much work remains ahead. While crises have motivated a great deal of reform in individual countries, and standards are approaching international norms, the international financial system remains a patchwork of varying standards and guidelines. While international disclosure standards have improved markedly in recent years, greater disclosure still is required, particularly with respect to bank asset quality, both in emerging and industrial countries alike. In seeking to make these improvements, however, we should avoid a “checklist” approach which may not address the risks of a given country and may soon become outdated. Improved disclosure will require more than a comprehensive framework. Accounting standards also need to be upgraded to reflect innovations in financial products and risk management techniques. The process of upgrading accounting standards, in turn, would benefit from greater harmonization of accounting standards that would facilitate comparison of global financial institutions and result in more uniform capital standards across countries.