European Central Bank publishes working paper finding releasable capital buffers preserve credit in downturns with limited upturn costs

The European Central Bank has published Working Paper No. 3257, which introduces the DeTail agent-based model to assess the state-contingent tail effects of releasable macroprudential capital buffers. The paper finds that releasing buffers in downturns improves adverse credit outcomes, reduces household and firm defaults and lowers tail bank losses, while building buffers in upturns imposes little cost on lending. The model also suggests that a time-varying buffer regime can shorten and modestly dampen credit cycles. The framework compares a regime with time-varying capital requirements against time-invariant requirements and focuses on credit growth, borrower defaults, bank losses and recapitalisation needs. In the downturn analysis, releasing the buffer raised the 25th percentile of real credit growth by about 2 percentage points and narrowed its interquartile range by about 2.7 percentage points relative to a fixed-buffer regime. The upper tail of default rates fell by 0.7 percentage points for firms and 1.2 percentage points for households, while the upper tail of bank losses declined by 0.9 percentage points and capital injections to keep banks above minimum requirements became smaller and less frequent. In the upturn analysis, buffer accumulation did not materially change credit growth, but slightly improved firm credit quality and bank loss outcomes. The paper models the time-varying regime as an 8% minimum capital requirement plus a releasable buffer of up to 2.5%, built up in response to smoothed real credit growth and released fully when a three-month moving average of unemployment exceeds 5%.