The risk-weighted capital framework for banks has changed significantly through the implementation of Basel III [Implemented in Europe through CRD IV/CRR.]. Banks are now required to hold a higher quantity and quality of capital, including a capital conservation buffer, which banks can run down during periods of stress, and a countercyclical capital buffer, which may be adjusted at the discretion of the macroprudential authorities.
There are three broad ways in which banks might respond to higher risk-weighted capital requirements:
• First, they may be able to offset the increase by reducing any voluntary buffers of capital above regulatory requirements, leaving overall capital levels unchanged. Banks typically fund themselves with more capital than they are required to hold by the regulatory framework to ensure that they do not breach regulatory requirements under most foreseeable circumstances.
• Second, some banks may seek to raise capital, either through retained earnings or b
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