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Housing and credit market shocks: Exploring the role of rule-based Basel III counter-cyclical capital requirements

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  • Liu, Guangling
  • Molise, Thabang

Abstract

This paper examines the extent to which the Basel III bank capital regulation attenuates fluctuations in housing and credit markets and fosters financial and macroeconomic stability. We use a positive housing demand shock to mimic a housing market boom and a negative financial shock for credit squeeze and economic meltdown. The results show that the rule-based Basel III counter-cyclical capital requirement effectively attenuates fluctuations in housing and credit markets and prevents bubbles. In the case of a negative financial shock, it significantly reduces the magnitude of economic meltdown. Our analysis of the transition from Basel II to Basel III suggests that it is the counter-cyclical capital buffer that effectively mitigates the pro-cyclicality of its predecessor, while the impact of the conservative buffer is marginal. In contrast to the credit-to-GDP ratio, the optimal policy analysis suggests that the regulatory authority should adjust the capital requirement to changes in credit and output when implementing the counter-cyclical buffer. Future research could extend the study by comparing the effectiveness of the rule-based Basel III with other macroprudential tools in achieving financial and macroeconomic stability.

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  • Liu, Guangling & Molise, Thabang, 2019. "Housing and credit market shocks: Exploring the role of rule-based Basel III counter-cyclical capital requirements," Economic Modelling, Elsevier, vol. 82(C), pages 264-279.
    • Handle: RePEc:eee:ecmode:v:82:y:2019:i:c:p:264-279
    DOI: 10.1016/j.econmod.2019.01.013
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    2. Ge, Xinyu & Li, Xiao-Lin & Zheng, Ling, 2020. "The transmission of financial shocks in an estimated DSGE model with housing and banking," Economic Modelling, Elsevier, vol. 89(C), pages 215-231.
    3. Gulan, Adam & Jokivuolle, Esa & Verona, Fabio, 2022. "Optimal bank capital requirements: What do the macroeconomic models say?," BoF Economics Review 2/2022, Bank of Finland.
    4. Martin Bolfek & Karmen Prtenjača Mažer & Berislav Bolfek, 2024. "What Are the Differences in the Area of Profitability and Efficiency When Early and Late Adopters Are Analyzed Regarding the Basel III Leverage Ratio?," JRFM, MDPI, vol. 17(1), pages 1-17, January.
    5. Pacicco, Fausto & Serati, Massimiliano & Venegoni, Andrea, 2022. "The Euro Area credit crunch conundrum: Was it demand or supply driven?," Economic Modelling, Elsevier, vol. 106(C).

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    More about this item

    Keywords

    Basel III; Counter-cyclical capital requirements; DSGE; Financial stability; Macroprudential policy;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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