The New Basel Capital Accord and the Cyclical Behaviour of Bank Capital
AbstractThe authors conduct a counterfactual simulation of the proposed rules under the new Basel Capital Accord (Basel II), including the revised treatment of expected and unexpected credit losses proposed by the Basel Committee in October 2003. When the authors apply the simulation to Canadian banking system data over the period 1984–2003, they find that capital requirements for banks will likely fall in absolute terms even after allowing for the new operational risk charge (bearing in mind that the induced behavioural response of banks to the changed incentives under Basel II is not captured). The impact on the volatility of required bank capital is less clear. It will depend importantly on the credit quality distribution of banks' loan portfolios and on the precise way in which they calculate expected and unexpected losses. Sensitivity analysis, including that based on a range of hypothetical distributions for banks' loan portfolios, shows the potential for a substantial increase in implied volatility. Moreover, if historical relationships are a good indicator of the future, changes in required capital and provisions for commercial and industrial, interbank, and sovereign exposures will likely be countercyclical under Basel II (i.e., capital requirements will increase during recessions). This raises questions about the new accord's potentially procyclical impact on banks' lending behaviour, and the resultant macroeconomic implications.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 04-30.
Length: 66 pages
Date of creation: 2004
Date of revision:
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Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- K23 - Law and Economics - - Regulation and Business Law - - - Regulated Industries and Administrative Law
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-08-31 (All new papers)
- NEP-FIN-2004-08-31 (Finance)
- NEP-LAW-2004-08-31 (Law & Economics)
- NEP-REG-2004-08-31 (Regulation)
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