Macroprudential and monetary policy interaction: the role of early activation of the countercyclical capital buffer

Prepared by Carsten Detken, Hannah S. Hempell and Mara Pirovano^[1]

Published as part of the Macroprudential Bulletin 31, August 2025.

Amid changes in the global macro-financial environment, macroprudential policy within the banking union and beyond has increasingly prioritised the proactive build-up of resilience. This article argues that the shift towards a more pre-emptive implementation of macroprudential policy has enhanced its complementarity with monetary policy. A sufficiently resilient financial sector is essential to excluding conflict between price stability and financial stability – the respective primary objectives of monetary policy and macroprudential policy, as highlighted in the ECB’s 2025 monetary policy strategy statement.^[2] Without sufficient resilience, monetary policy could at times negatively affect financial stability, for example when the monetary policy stance remains very accommodative for extended periods or undergoes significant tightening over a short time span. In particular, the early activation of the countercyclical capital buffer (CCyB) fosters banking sector resilience by ensuring the availability of sufficient capital that can be released in the event of shocks (including non-financial ones). This approach helps monetary policy focus on its primary objective of price stability, thereby largely eliminating the potential for conflict between price stability and financial stability.

1 Introduction

Amid changes in the global macro-financial environment, macroprudential policy has increasingly focused on the pre-emptive build-up of resilience, enhancing its complementarity with monetary policy. The degree of uncertainty and non-financial (e.g. supply) shocks unrelated to the materialisation of endogenous financial sector imbalances have become more relevant over recent years. Events like the COVID-19 pandemic and the economic consequences of Russia’s invasion of Ukraine were non-predictable shocks that were not related to an endogenous build-up of financial sector imbalances – in other words, they were unrelated to excessive credit growth or house price booms. Most importantly, this highlighted the importance of ensuring through-the-cycle resilience in the financial sector by increasing the availability of releasable capital buffers.^[3] These events triggered a shift in emphasis in macroprudential policy towards building up macroprudential space and resilience pre-emptively. This article highlights the implications of the latest developments in the implementation of macroprudential policy for the complementary role it plays with monetary policy. It specifically examines the potential role of early activation approaches to the setting of the CCyB within a broader-based focus on resilience and their implications for interaction between the two policy areas. While the ECB’s 2021 strategy review had already acknowledged this complementarity, the ECB has further detailed this stance in its latest 2025 monetary policy strategy assessment by stressing that the resilience of the financial sector is a necessary condition to prevent a potential conflict between price and financial stability. Macroprudential policy’s recent more pre-emptive focus on resilience further enhances this complementarity and strengthens the role of macroprudential policy as the first line of defence in an environment of heightened geopolitical and macro-financial uncertainty.

2 Macroprudential policy: increased focus on early build-up of resilience

Prior to the COVID-19 pandemic, macroprudential policy in the euro area focused on limiting the build-up of systemic risk in an environment of accommodative monetary policy. During this period, the build-up of vulnerabilities mainly happened in the residential real estate sector, with several jurisdictions experiencing rapid growth in property prices and rising household indebtedness, while general credit developments remained muted. Macroprudential policy actions therefore focused on addressing these emerging vulnerabilities with targeted capital-based measures, while the use of broader, releasable capital buffers such as the CCyB remained sparse. This course of action was consistent with the prevailing use of the CCyB as an instrument aimed at mitigating cyclical systemic risks related to excessive credit developments, with its activation contingent on the evolution of indicators such as the Basel credit-to-GDP gap and other indicators mainly linked to credit developments. As a result, at the onset on the pandemic only a few countries had a positive CCyB rate in place; in other words, sufficient capital which could be released to provide relief to the banking sector and support lending to the economy.^[4]

The experience of the COVID-19 pandemic led to a reconsideration of the role of releasable capital buffers and to a renewed focus on strengthening resilience in macroprudential policy. In the aftermath of the great financial crisis, the use of macroprudential instruments was guided by the dual objective of increasing the banking sector’s resilience and taming the upswing of the financial cycle (Constâncio et al., 2019). The outbreak of the pandemic and the unprecedented consequent economic shock showed that adverse shocks with potentially disruptive implications for the financial system could occur in any phase of the financial cycle. Furthermore, these experiences reminded policymakers that adverse financial developments could also be unrelated to previous exuberance in the financial sector and could originate from non-financial shocks. These considerations brought to the fore the desirability of pre-emptively building up capital buffers that could be released in the event of adverse shocks to enable banks to absorb losses and continue lending to the real economy. Several macroprudential authorities therefore started to put an increasing focus on the resilience objective of macroprudential policy, which aimed to ensure banks’ ability to continue providing key financial services to the real sector in all phases of the cycle, including under stress. The key lesson learned stressed the need to hold sufficient releasable prudential capital buffers.

As a result, and despite a tightening in the monetary environment since 2022, macroprudential policy has continued focusing on strengthening banking sector resilience and macroprudential capital buffers have been increased in several euro area countries. Russia’s invasion of Ukraine in 2022 and the ensuing global supply-chain pressures and large rises in commodity and energy prices led to rising and persistent inflationary pressures. These triggered an unprecedented monetary policy tightening whereby the ECB’s deposit facility rate (main refinancing operations rate) rose from -0.5% (0%) in July 2022 to 4% (4.5%) in September 2023 and was subsequently reduced as of June 2024. The supply-side shocks and the monetary policy tightening were accompanied by an orderly financial cycle downturn characterised by falling credit and real estate prices. Notwithstanding these developments, several macroprudential authorities in the banking union activated macroprudential capital buffers in 2022 and 2023, increasing releasable capital buffer requirements such as the countercyclical capital buffer (CCyB) and the (sectoral) systemic risk buffer (SyRB) (Chart 1) to increase the resilience of their banking sectors in uncertain times. Exceptionally high bank profitability (driven by the monetary tightening and coupled with banks’ large holdings of central bank reserves) and the ample voluntary capital buffers held by banks limited the cost of such capital buffer increases for banks and the economy (Lang and Menno, 2023 and Herrera et al., 2024).

Chart 1

Macroprudential capital requirements were increased in several countries during the recent period of monetary tightening

Evolution of the ECB’s deposit facility rate and announced increases in releasable capital requirements

(percentages)

The increased focus on resilience and broader appreciation of the need to hold releasable capital buffers have led macroprudential authorities to adopt more proactive approaches to the setting of capital buffers, most notably the CCyB. Currently, 17 countries in the European Economic Area, ten of which are in the banking union, have revised their frameworks for setting the CCyB and introduced a positive rate for the buffer early in the financial cycle, when cyclical systemic risks are not yet elevated (see ECB/ESRB, 2025 and BCBS, 2024). These early activation approaches often include a target “positive neutral” CCyB rate and fulfil the triple objective of: i) building up capital buffers in good time to ensure resilience against potential unidentified systemic risks, or systemic risks that have not yet been captured by established risk indicators owing to data lags; ii) ensuring that sufficient buffers are available in the early phases of the cycle, also to increase resilience against exogenous shocks that could occur at any phase of the financial cycle^[5]; and iii) allowing for a more gradual, and therefore less costly, build-up of capital buffers over the cycle. Overall, macroprudential measures have led to a remarkable increase in releasable capital buffers. At the time of writing, all countries in the banking union have releasable capital buffers in place (Chart 2). These policy actions have resulted in a noticeable increase in macroprudential space in the euro area: from 0.35% of domestic risk-weighted assets in December 2019 to around 1% in December 2024.^[6]

Chart 2

Macroprudential measures have resulted in a significant increase in macroprudential space since the COVID-19 pandemic

Announced releasable capital buffer rates (CCyB and SyRB) in the euro area

(percentages)

3 Interaction of resilience-focused macroprudential policy with the monetary policy stance

3.1 Complementarity between macroprudential and monetary policy

While macroprudential policy and monetary policy are to a large extent complementary, monetary policy may generate relevant spillovers for financial stability. With respect to their mandates, monetary policy primarily aims at ensuring price stability, while macroprudential policy aims at safeguarding financial stability. Both policies operate through some common transmission mechanisms and generally enhance their mutual effectiveness. However, they may also generate unintended side effects. By setting policy rates or affecting the yield curve via balance sheet policies, monetary policy can have a notable impact on the financial cycle and, potentially, on financial stability itself.^[7] Generally, monetary policy can have effects of a different sign on short-term and medium-term financial stability: a loosening of monetary policy reduces systemic risk in the short-term while possibly increasing the build-up of systemic risk in the medium-term through its expansionary effect on credit, leverage, asset prices and risk-taking. By contrast, monetary tightening – particularly in conjunction with supply-led inflation – may trigger a higher probability of short-term systemic risk materialising via interest rate risk, credit risk and liquidity channels.^[8] However, by discouraging indebtedness, increasing bank net interest income and fostering price stability it can reduce financial vulnerabilities and systemic risks in the medium term. These intertemporal policy interactions imply that monetary policy can generate spillovers that are relevant for financial stability.^[9] Hence, the monetary policy stance should matter for the design, timing and calibration of macroprudential measures.^[10] Two important questions arise: to what degree should monetary policy take these possible spillovers to financial stability into account in its decision making? What role does macroprudential policy play in this regard?

In its strategy review published in 2021 the ECB already emphasised the complementarity of macroprudential and monetary policy. Its 2025 monetary policy strategy assessment also clearly acknowledges that financial stability is a precondition for price stability, and vice versa. It thereby confirms the complementarity of objectives and underscores the importance of taking financial stability considerations into account in monetary policy deliberations. Complementarity with respect to enhancing mutual policy effectiveness is most evident when financial and business cycles are synchronised and both policies align in either a tightening or loosening direction, thereby reinforcing each other. During periods of financial cycle expansion and above-target inflation, higher macroprudential cyclical capital buffers would complement a tighter monetary policy stance by increasing lending rates and reducing risk-taking incentives, while tighter borrower-based measures would promote more prudent lending. However, de-synchronised business and financial cycles, as well as inflationary supply shocks, challenge the traditional notion of complementarity between macroprudential policy and monetary policy, which may need to act in different directions and may, therefore, not be complementary from a cyclical perspective. This could happen, for example, when financial contraction occurs alongside high inflation, warranting a monetary policy tightening and a macroprudential loosening. However, the latter argument is only relevant to the traditional focus of countercyclical macroprudential policy, which is aimed at smoothing credit cyclicality.

The renewed focus of macroprudential policy on resilience expands the notion of complementarity with monetary policy and further strengthens its role as a first line of defence. As was already highlighted in the context of the ECB’s 2021 strategy review, when neither macroprudential policy nor monetary policy is constrained, it is optimal for each policy to concentrate primarily on its own objectives, i.e. financial stability for macroprudential policy and price stability for monetary policy, while considering the other as given.^[11] This approach aligns with the Tinbergen rule, which advocates using one policy instrument to target one objective. However, when policies face constraints, macroprudential measures that enhance financial system resilience and ensure the availability of releasable capital buffers become essential to optimal policy interaction. Additionally, significant shifts in monetary policy, regardless of their direction, may lead to the build-up of financial stability risks, creating the need for macroprudential policy to strengthen resilience against these vulnerabilities. In this interplay, macroprudential policy serves as the first line of defence against financial stability risks, but also needs to be responsive to significant changes in the monetary policy stance that could pose additional risks. Sufficient loss-absorbing capacity within the financial system enables the two primary policy objectives, financial stability and price stability, not to be in conflict.

In a monetary union with a homogenous monetary policy, the flexibility of macroprudential policies can account for heterogeneities at the country, sector and institutional level to safeguard resilience against systemic risks. Heterogeneities driven by different regulatory and institutional settings and the differing structural features of financial sectors, fragmented markets, de-synchronised cycles and exogenous shocks may all contribute to asymmetries in the build-up of systemic vulnerabilities across countries and exposure to systemic shocks. Targeted and more granular macroprudential policies allow these risks to be addressed in a more tailored manner, complementing the euro area-wide monetary policy by limiting potential unintended side effects in specific jurisdictions and/or sub-segments of the macro-financial system.

3.2 Early activation of releasable buffers and interactions with monetary policy stance

The early activation of releasable capital buffers such as the CCyB enhances macroprudential space and strengthens the countercyclical potential of macroprudential policy. Early activation approaches to the setting of the CCyB aim to pre-emptively increase the resilience of the banking sector in the early stages of the financial cycle. As shown in Chart 3, early activation approaches aim for a gradual build-up of the CCyB towards the target “positive neutral” rate, when cyclical systemic risks are neither subdued nor elevated. Favourable conditions in the banking sector and a stable macro-financial environment are key factors in determining the right time to activate the CCyB to mitigate the macroeconomic costs of increasing capital requirements (ECB/ESRB, 2025 and Lang and Menno, 2023.^[12] When cyclical systemic vulnerabilities become elevated, the CCyB is then further increased to the level considered appropriate to address them.

Chart 3

Setting of the CCyB through the cycle: traditional versus early activation approach

A more proactive approach to activating capital buffers enhances the complementarity between macroprudential and monetary policy in an environment of heightened uncertainty. By pre-emptively increasing the loss-absorbing capacity of the banking sector early in the cycle, macroprudential policy prepares the system to absorb and mitigate unexpected shocks and potential side effects associated with monetary policy tightening or loosening. Boxes 1 and 2 simulate this increase in loss absorption capacity via early activation of releasable buffers in a dynamic stochastic general equilibrium (DSGE) framework and with a granular stress-testing simulation tool. The early activation of releasable buffers widens monetary policy’s room for manoeuvre, allowing it to focus on its main objective of achieving price stability. Second, pre-emptively building up releasable buffers entrusts macroprudential policy with additional countercyclical power in the event of (disinflationary) adverse shocks, which may occur at any phase of the cycle. By releasing capital buffers, macroprudential policy can support bank lending to the real economy, thereby complementing monetary policy.

Benign banking conditions have supported the recent early activation of releasable buffers during monetary tightening and have prevented unwarranted procyclicalities. As shown in Box 2, during the 2022-2023 period of monetary policy tightening, benign banking conditions such as ample initial capital headroom and high bank profitability have supported the smooth implementation of the recent early activation of releasable buffers in several euro area countries. These favourable conditions meant that increases in capital requirements only had a marginal impact on banks’ ability to redistribute profits, as they were largely compensated for by extraordinary bank returns during this time. High bank profitability along with mostly ample initial capital headroom likewise prevented deleveraging pressures.

Box 1
Simulations of early activated countercyclical capital buffers under alternative monetary environments and stress conditions

Prepared by Luis Herrera

This box presents simulations using the dynamic stochastic general equilibrium (DSGE) model developed by Herrera et al. (2025) to illustrate the increased complementarity between macroprudential and monetary policy stemming from the early activation of releasable capital buffers.

Activating the countercyclical capital buffer (CCyB) early in the cycle can offset the potential side effects of monetary policy tightening on financial stability, thereby allowing monetary policy to focus on its price stability objective. To assess the benefits of early CCyB activation, a cost-push shock leading to a surge in inflation and a drop in GDP is simulated. Specifically, it is assumed that the shock occurs in an environment where cyclical systemic risks are not building up (i.e. a “standard” risk environment) and the CCyB has not been activated. To bring inflation back to the target, the monetary policy authority reacts to the shock by increasing the monetary policy rate. Two alternative scenarios are simulated: a baseline scenario (solid yellow line in Chart A, panel a) and one in which the monetary authorities adopt a tighter stance, increasing the policy rate more forcefully (solid red line in Chart A, panel a). The monetary policy tightening increases banks’ default probability through its effect on their cost of funding, with a more forceful monetary policy reaction leading to more pronounced effects on financial stability. However, if a CCyB is activated prior to the occurrence of the adverse shock (dashed lines in Chart A, panel a), the additional resilience provided by the capital buffer allows the negative side effects of the monetary policy tightening on financial stability to be mitigated, without affecting the effectiveness of the monetary policy reaction in terms of stabilising inflation.

Furthermore, if monetary policy tightening triggers a materialisation of risks leading to financial distress even in a standard risk environment, early activation of the CCyB can help mitigate these adverse effects. A second simulation examines the effects of financial stability risks materialising in an environment of high interest rates. Specifically, the economy experiences an adverse financial shock, involving a rise in bank funding costs. This shock is calibrated to trigger a 5 percentage-point increase in the aggregate banking sector’s default probability. If a CCyB has been activated despite systemic risks not being elevated, banks are better placed to withstand the shock, continue lending to households and firms and mitigate the impact of the shock on economic activity. As shown in Chart A, panel b), with additional capital available through early CCyB activation, the GDP contraction under the adverse scenario is 0.2 percentage points smaller (yellow bar) compared with the case where macroprudential buffers are not in place (blue bar). Additionally, the increase in banks’ default probability is 3.5 percentage points lower.

Chart A

Early CCyB activation mitigates the potential side effects of monetary policy tightening and smoothens the impact of adverse shocks that occur early in the financial cycle

a) Mitigation capacity of the positive neutral rate for monetary policy side effects

(y-axes: percentage deviations from steady state (GDP) and percentage point deviation from steady state, annualised (inflation, banks’ default probability and policy rate); x-axes: quarters)

b) Mitigation capacity of the positive neutral rate in a financial distress scenario

(y-axes: percentage deviations from steady state (GDP) and percentage point deviation from steady state, annualised (banks’ default probability)

Box 2
Costs and benefits of releasable buffers activated during monetary policy tightening

Prepared by Elena Rancoita, Matteo Normanno and Annika Oberhuber

This box presents a cost and benefit assessment of releasable macroprudential buffers (the CCyB and SyRB) whose activation was announced during the period of monetary policy tightening between the fourth quarter of 2022 and the third quarter of 2023. The analysis is performed by means of a stress-testing simulation tool relying on granular bank-level information.^[13] The costs of buffer implementation are measured in terms of their repercussions on banks’ redistributive payout yields.^[14] The empirical literature shows that banks might respond to a tightening of capital requirements by constraining dividend payouts and/or by de-risking. However, more recent studies suggest that lending has a lower sensitivity to changes in capital requirements when bank capitalisation is high, limiting the impact on profitability.^[15] The medium-term benefits of the implemented policies are evaluated by looking at how they would affect banks’ resilience if risks were to materialise and buffers were released.

Chart B

Activating buffers during monetary policy tightening can mitigate implementation costs and their release can offset procyclical impact on lending under mild stress, with some country heterogeneity

a) Joint impact on the payout yield of rate hikes and buffer tightening

(percentage of book equity)

b) Capital headroom under stress vs mitigating impact of releasable buffers

(percentage of risk-weighted assets)

The activation of macroprudential buffers during the tightening of monetary policy rates in 2022-2023 only had a marginal impact on banks’ ability to redistribute profits and these costs were largely compensated for by the impact of extraordinary bank returns. Intuitively, monetary policy tightening can help reduce the costs of implementing macroprudential buffers through its positive short-run effects on banks’ profitability,^[16] thereby increasing the likelihood of banks meeting their dividend distribution targets. Between the second quarter of 2022 and the third quarter of 2023, short-term rates increased by 4 percentage points and macroprudential measures were tightened in 13 countries (Chart 1).^[17] Simulation results indicate a marginally negative impact of the buffer announcements on payout yields (-60 basis points against an average payout yield of 5% in the fourth quarter of 2023), which has been more than compensated for by the higher returns under the increased policy rates (+95 basis points) (Chart B, left-hand side of panel a). Taking these effects together, the impact of implementing releasable buffers on redistribution targets under monetary policy tightening is negligible.^[18] Looking at the distribution across banks, the impact on banks’ redistribution is similar for capital constrained and unconstrained banks (Chart B, right-hand side of panel a). However, the results of this analysis should be interpreted with caution and cannot be generalised to define other periods. In the period considered, the impact of interest rate hikes on banks’ profits was amplified by the abundant central bank liquidity still available to banks after the pandemic.^[19] In several euro area countries, the resulting extraordinary bank profits were even taxed with ad hoc levies over the same period.^[20]

Simulation results show that the buffers currently implemented are expected to mitigate the impact of risk materialising in a mild stress scenario, but with significant heterogeneity across countries. All countries which have implemented releasable buffers would currently benefit from additional capital space if risks were to materialise. Simulations show that the capital headroom in a standard stress environment would be depleted by about 50 basis points of risk-weighted assets after one year, losses which could be absorbed by the release of macroprudential buffers^[21] (Chart B, left-hand side of panel b). For this reason, the stress scenario is not expected to have an impact on the provision of credit to the real economy at aggregate level. However, there is significant heterogeneity across countries. Chart B (right-hand side of panel b) shows the effective capital headroom under stress with full release of macroprudential buffers against the capital depletion net of the release of buffers. It shows that most of the countries where releasable buffers are not sufficient to mitigate stress losses are also those where the final capital headroom would be the lowest and could be more prone to procyclical deleveraging.^[22]

4 Conclusions

The recent shift towards stressing pre-emptive resilience as a macroprudential policy objective is a reaction to changes in the global macro-financial landscape. Before the COVID-19 pandemic, most macroprudential policy measures taken in the euro area were focused on curbing systemic risks amid accommodating monetary conditions. However, events like the pandemic and the economic effects of Russia’s invasion of Ukraine underscored the importance of preparing for non-cyclical, supply-driven shocks, which reduce output and simultaneously increase inflation. This prompted a re-evaluation of the use of releasable capital buffers and a renewed emphasis on enhancing resilience, amid a tightening of monetary conditions between 2022 and 2024. Consequently, several euro area countries have increased their macroprudential capital buffers, and half of all euro area countries are now applying the concept of early activation of the CCyB.

This proactive approach enhances the complementarity between macroprudential and monetary policy amid heightened uncertainty. While these two policies are largely complementary, monetary policy also affects the financial cycle and can potentially affect financial stability risks. Macroprudential policy acts as the first line of defence against financial stability risks and should adapt to shifts in monetary policy that could exacerbate existing vulnerabilities or trigger new ones. The ECB’s latest monetary policy strategy statement has stressed that resilience and thereby adequate loss-absorbing capacity within the financial system helps avoid potential situations of trade-off between price and financial stability. The trend of activating capital buffers like the CCyB early creates macroprudential space and bolsters the countercyclical potential of macroprudential policy in a situation of financial risk materialisation, thereby strengthening the complementarity between macroprudential policy and monetary policy. This complementarity extends beyond a mutually reinforcing influence on financial and economic cycles in times when the policies move in the same direction. Complementarity is reinforced because when prudential policy makes the financial sector sufficiently resilient, monetary policy can persistently pursue its objective of price stability without compromising financial stability. It is precisely the resilience of the euro area financial sector which has recently allowed monetary policy to tighten its stance so significantly and preserve price stability. The early activation of macroprudential buffers, together with sound microprudential supervision, has helped build up the resilience needed to sustain a swift 450 basis point hike in the policy rate unscathed.

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