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When a bank holds a lot of safe assets, it is well situated to deal with funding stress. But when all banks hold a lot of safe assets, a pecuniary externality implies that their (wholesale) funding costs increase. This reduces banks’ ability to hold capital buffers and thus, paradoxically, increases the frequency of funding stress.

Time-varying capital buffer requirements are a powerful tool that allow bank regulators to avoid severe financial stress without the cost of imposing very high levels of capital. However, this tool is only effective if banks understand how it is used. I present a model that banks and financial market participants can use to anticipate how time-varying capital buffer requirements change over time.

Countercyclical capital buffers are regulatory measures developed in response to the global financial crisis of 2008–09. This note focuses on how time-varying capital buffers can improve financial stability in Canada