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Procyclicality: The Macroeconomic Impact of Risk-Based Capital Requirements

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  • Bernd Hofmann

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    Abstract

    Recent research on the Basel II capital framework suggests that binding capital requirements may be responsible for bank behaviour which causes procyclical amplifications of the macroeconomic cycle. This paper presents a model of the interrelations between the state of the economy, credit risk, and loan supply to clarify and quantify this effect. Special attention is paid to the fact that both regulatory and economic capital requirements can significantly influence loan supply, provided that they are binding. The model shows that both economic capital, based on a one-factor model, and the regulatory IRB requirements cause more procyclicality than the constant regulatory requirements of the Basel I capital accord. However, the overall impact depends on the interrelation of the regulatory requirements with economic capital. Based on this result, the replacement of the Basel I requirements with risk-sensitive IRB capital requirements boosts procyclicality under most, but not under all conditions. Copyright Swiss Society for Financial Market Research 2005

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    Bibliographic Info

    Article provided by Springer in its journal Financial Markets and Portfolio Management.

    Volume (Year): 19 (2005)
    Issue (Month): 2 (August)
    Pages: 179-200

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    Handle: RePEc:kap:fmktpm:v:19:y:2005:i:2:p:179-200

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    Web page: http://www.springerlink.com/link.asp?id=119763

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    Cited by:
    1. Juan Sebastián Amador Torres & José EDuardo Gómez G. & Andrés Murcia Pabón, 2013. "Loans Growth and Banks’ Risk: New Evidence," Borradores de Economia 763, Banco de la Republica de Colombia.
    2. Marc Ryser & Stefan Denzler, 2009. "Selecting credit rating models: a cross-validation-based comparison of discriminatory power," Financial Markets and Portfolio Management, Springer, vol. 23(2), pages 187-203, June.

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