The effective capital requirement may also increase during downturns if it is
risk sensitive. Under proposals by the Basel Committee on Banking Supervision to reform capital requirements, the level of required regulatory capital would increase as the credit risk of the assets held in the loan portfolio increases. In a downturn, not only do more loans default, but the default risk of performing loans (in aggregate) tends to increase.This translates into an increase in the effective required regulatory capital ratio, and further reduces the level of earning assets that the banking system can support on the existing (remaining) capital base.
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