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The Procyclical Effects of Bank Capital Regulation

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  • Repullo, R.
  • Suarez, J.

    (Tilburg University, Center for Economic Research)

Abstract

We assess the procyclical effects of bank capital regulation in a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period. Banks anticipate that shocks to their earnings as well as the cyclical position of the economy can impair their capacity to lend in the future and, as a precaution, hold capital buffers. We find that under cyclically-varying risk-based capital requirements (e.g. Basel II) banks hold larger buffers in expansions than in recessions. Yet, these buffers are insufficient to prevent a significant contraction in the supply of credit at the arrival of a recession. We show that cyclical adjustments in the confidence level underlying Basel II can reduce its procyclical effects on the supply of credit without compromising banks’ long-run solvency targets.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2010-29S.

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Date of creation: 2010
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Handle: RePEc:dgr:kubcen:201029s

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Web page: http://center.uvt.nl

Related research

Keywords: Banking regulation; Basel II; Business cycles; Capital requirements; Credit crunch; Loan defaults; Relationship banking;

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  1. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises," IMF Working Papers 08/224, International Monetary Fund.
  2. Koopman, Siem Jan & Lucas, Andre & Klaassen, Pieter, 2005. "Empirical credit cycles and capital buffer formation," Journal of Banking & Finance, Elsevier, vol. 29(12), pages 3159-3179, December.
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