Bank Lending and Regulation in Insider Financial Systems: A Theoretical Assessment

Numerous studies have been conducted to evaluate the impact of the Basel II framework of banking regulation on specific groups of companies, including small and medium-sized enterprises. Additionally, quantitative impact studies have shown the effects at a macroeconomic level. Despite these fields of intensive research which rely heavily on econometric data evaluation, a concise integration of these methods of economic policy into monetary theory is still outstanding. Therefore, this chapter attempts to fill this theoretical gap by integrating the effects of modern banking regulation into an endogenous money model. The aim of the new Basel II accord is to minimize bank risks by paying special attention to adequate credit risk assessment. Other risks, such as market risks and operational risks, are also integrated into the new capital adequacy ratios; but these play only a minor role in the overall economic analysis since the changes in the assessment of these risks from Basel I to Basel II framework were relatively minimal. Consequently, this chapter focuses on the effects of the introduction of new methods of credit risk assessment in Pillar I (capital adequacy ratio) of Basel II and investigates how bank lending is affected by addressing the following question: From a theoretical point of view, do modern forms of banking regulation lead to credit constraints within economies with insider financial systems? As Basel I led to an increase in securitization, which in turn minimized the influence of central bank policies on commercial banks’ behaviour, the second research question addressed in this chapter is whether the new accord achieves its aim of further increasing the influence of central banks policies.