The financial system is inherently Procyclical—it tends to amplify the movements of the broader economic cycle. During economic expansions, rising asset values and low default rates encourage commercial banks to loose credit standards, increasing leverage and driving asset bubbles.

This self-reinforcing credit loop accelerates economic growth during booms but increases systemic vulnerability to sudden corrections:

[Asset Valuations Rise] ---> [Collateral Value Spikes] ---> [Banks Expand Credit Supply] ---> [Leverage Accumulates]

When the economic cycle turns and asset values fall, the loop reverses. Falling collateral values force banks to restrict lending and call in loans, triggering a severe credit crunch that deepens the recession. Macroprudential authorities implement countercyclical tools to break this loop, slowing credit creation during booms and supporting lending during downturns.