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Procyclical implications of Basel II: Can the cyclicality of capital requirements be contained?

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  • Andersen, Henrik
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    Abstract

    While the current capital adequacy framework, Basel II, aims to make banks' capital requirements more sensitive to the underlying risk of the assets, it may also introduce an additional source of procyclicality in the banking sector. In this paper we assess the potential cyclicality of Basel II for the entire bank portfolio. This is in contrast to previous studies which have taken into account only parts of banks' assets, and also neglected the potential cyclicality of bank capital. We apply a detailed data set covering a relatively long period to analyse the cyclicality of both bank capital and Basel II capital requirements. Moreover, we employ a more comprehensive system of models than applied in the existing literature. Consistent with previous evidence, we find a substantial increase in the calculated Basel II capital requirements at the same time as bank capital deteriorates in a recession scenario. However, we also find that the cyclicality of Basel II capital requirements may be effectively contained if risk weightings are based on a sufficiently long observation period which includes economic downturns.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Stability.

    Volume (Year): 7 (2011)
    Issue (Month): 3 (August)
    Pages: 138-154

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    Handle: RePEc:eee:finsta:v:7:y:2011:i:3:p:138-154

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    Web page: http://www.elsevier.com/locate/jfstabil

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    Keywords: Basel II Procyclicality Capital positions;

    References

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    1. Eva Catarineu-Rabell & Patricia Jackson & Dimitrios Tsomocos, 2005. "Procyclicality and the new Basel Accord - banks’ choice of loan rating system," Economic Theory, Springer, vol. 26(3), pages 537-557, October.
    2. Charles Goodhart & Boris Hofmann & Miguel Segoviano, 2004. "Bank Regulation and Macroeconomic Fluctuations," Oxford Review of Economic Policy, Oxford University Press, vol. 20(4), pages 591-615, Winter.
    3. Jaap Bikker & Paul Metzemakers, 2004. "Is bank capital procyclical? A cross-country analysis," DNB Working Papers 009, Netherlands Central Bank, Research Department.
    4. Henrik Andersen, 2008. "Failure prediction of Norwegian banks: A Logit approach," Working Paper 2008/02, Norges Bank.
    5. Ayuso, Juan & Perez, Daniel & Saurina, Jesus, 2004. "Are capital buffers pro-cyclical?: Evidence from Spanish panel data," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 249-264, April.
    6. Anil Kashyap & Jeremy C. Stein, 2004. "Cyclical implications of the Basel II capital standards," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 18-31.
    7. Jokipii, Terhi & Milne, Alistair, 2011. "Bank capital buffer and risk adjustment decisions," Journal of Financial Stability, Elsevier, vol. 7(3), pages 165-178, August.
    8. Frank Dierick & Fatima Pires & Martin Scheicher & Kai Gereon Spitzer, 2005. "The New Basel Capital Framework and its implementation in the European Union," Occasional Paper Series 42, European Central Bank.
    9. Jokivuolle, Esa & Virolainen, Kimmo & Vähämaa, Oskari, 2008. "Macro-model-based stress testing of Basel II capital requirements," Research Discussion Papers 17/2008, Bank of Finland.
    10. Bardsen, Gunnar & Eitrheim, Oyvind & Jansen, Eilev S. & Nymoen, Ragnar, 2005. "The Econometrics of Macroeconomic Modelling," OUP Catalogue, Oxford University Press, number 9780199246502, September.
    11. Henrik Andersen & Sigbjørn Atle Berg & Eilev S. Jansen, 2008. "The dynamics of operating income in the Norwegian banking sector," Working Paper 2008/13, Norges Bank.
    12. Claudio Borio & Craig Furfine & Philip Lowe, 2001. "Procyclicality of the financial system and financial stability: issues and policy options," BIS Papers chapters, in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 1-57 Bank for International Settlements.
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    Cited by:
    1. André K. Anundsen & Eilev S. Jansen, 2013. "Self-reinforcing effects between housing prices and credit: an extended version," Discussion Papers 756, Research Department of Statistics Norway.
    2. Tasca, Paolo & Battiston, Stefano, 2013. "Market Procyclicality and Systemic Risk," MPRA Paper 45156, University Library of Munich, Germany, revised Mar 2013.
    3. Anundsen, André K. & Jansen, Eilev S., 2013. "Self-reinforcing effects between housing prices and credit," Journal of Housing Economics, Elsevier, vol. 22(3), pages 192-212.
    4. Rossignolo, Adrian F. & Fethi, Meryem Duygun & Shaban, Mohamed, 2012. "Value-at-Risk models and Basel capital charges," Journal of Financial Stability, Elsevier, vol. 8(4), pages 303-319.
    5. Riccetti, Luca & Russo, Alberto & Mauro, Gallegati, 2013. "Financial Regulation in an Agent Based Macroeconomic Model," MPRA Paper 51013, University Library of Munich, Germany.
    6. Wall, Larry D., 2013. "Measuring capital adequacy supervisory stress tests in a Basel world," Working Paper 2013-15, Federal Reserve Bank of Atlanta.
    7. Xin Huang & Hao Zhou & Haibin Zhu, 2010. "Assessing the systemic risk of a heterogeneous portfolio of banks during the recent financial crisis," BIS Working Papers 296, Bank for International Settlements.
    8. Markus Behn & Rainer Haselmann & Paul Wachtel, 2013. "Pro-Cyclical Capital Regulation and Lending," Working Papers 13-11, New York University, Leonard N. Stern School of Business, Department of Economics.
    9. Clara Cardone-Riportella & Antonio Trujillo-Ponce & Anahí Briozzo, 2013. "Analyzing the role of mutual guarantee societies on bank capital requirements for small and medium-sized enterprises," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 16(2), pages 142-159, June.

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