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Better “financial soundness” of banks could help mitigate the volatility of financial cycles by reducing banks’ risk exposure. But trying to improve financial soundness in the midst of a downturn can do the opposite—further aggravating the contraction of credit. Consistent with this notion, the paper found that better initial scores in certain financial soundness indicators (FSIs) are associated with milder and shorter downturns; and improving FSIs during a downturn worsens the shrinkage of credit and amplifies the cycle. In this context, our results suggest that policy makers should be mindful about the timing of regulating changes in banks’ FSIs.

Banks and banking --- Business cycles --- Risk --- Economics --- Uncertainty --- Probabilities --- Profit --- Risk-return relationships --- Agricultural banks --- Banking --- Banking industry --- Commercial banks --- Depository institutions --- Finance --- Financial institutions --- Money --- Econometric models. --- Econometric models --- E-books --- Banks and Banking --- Finance: General --- Macroeconomics --- Money and Monetary Policy --- Financial Markets and the Macroeconomy --- Monetary Policy, Central Banking, and the Supply of Money and Credit: General --- Financial Crises --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- General Financial Markets: Government Policy and Regulation --- Business Fluctuations --- Cycles --- Financing Policy --- Financial Risk and Risk Management --- Capital and Ownership Structure --- Value of Firms --- Goodwill --- Monetary economics --- Financial services law & regulation --- Financial soundness indicators --- Credit --- Credit cycles --- Financial cycles --- Financial sector policy and analysis --- Exchange rate risk --- Financial regulation and supervision --- Financial services industry --- Financial risk management --- Belgium