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Banking regulation, procyclicality, and asset correlations in the real economic environment

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  • Pietro Vozzella
  • Giampaolo Gabbi

Abstract

Banking regulations have often been viewed as possible sources of procyclicality. We aim to provide a critical assessment of the risk-weighted asset estimates through the relationship between asset correlation and the probability of default as stated by international regulators. Our findings show that the relationship between asset correlation and size is not linear and also changes with the economic cycle. A risk-weighted asset computed according to regulatory assumptions would not generate the required capital relief during the downturn phase, when banks should release credit resources to support firms’ resilience. Therefore, we propose to transform the regulatory approach to empower the procyclical issues that still remain in upturns and slowdowns in economic cycles.

Suggested Citation

  • Pietro Vozzella & Giampaolo Gabbi, 2022. "Banking regulation, procyclicality, and asset correlations in the real economic environment," The European Journal of Finance, Taylor & Francis Journals, vol. 28(13-15), pages 1383-1398, October.
    • Handle: RePEc:taf:eurjfi:v:28:y:2022:i:13-15:p:1383-1398
    DOI: 10.1080/1351847X.2020.1857290
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