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Basel and procyclicality: a comparison of the standardised and IRB approaches to an improved credit risk method

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  • Goodhart, Charles
  • Segoviano, Miguel A.

Abstract

The regulation of bank capital in the form of capital adequacy requirements is itself inherently procyclical; it bites in downturns, but fails to restrain in booms. The more risk-sensitive the regulation, the greater the scope for pro-cyclicality to become a problem, particularly in view of the changing nature of macroeconomic cycles. The simulation exercises performed in this paper suggest that the new Basel II accord, which deliberately aimed at significantly increasing the risk sensitiveness of capital requirements, may in fact considerably accentuate the procyclicality of the regulatory system. Since the experience in the past, also discussed in this paper, suggests that a required hoisting of capital ratios in downturns may be brought about by cutting back lending rather than raising capital, the new capital accord may therefore lead to an amplification of business cycle fluctuations, especially in downturns.

Suggested Citation

  • Goodhart, Charles & Segoviano, Miguel A., 2004. "Basel and procyclicality: a comparison of the standardised and IRB approaches to an improved credit risk method," LSE Research Online Documents on Economics 24821, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:24821
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    References listed on IDEAS

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    Cited by:

    1. Charles Goodhart & Miguel Segoviano, 2009. "Banking Stability Measures," FMG Discussion Papers dp627, Financial Markets Group.
    2. Mr. C. A. E. Goodhart & Miguel A. Segoviano, 2009. "Banking Stability Measures," IMF Working Papers 2009/004, International Monetary Fund.
    3. Piotr Wdowiński, 2013. "Banking Sector and Real Economy of Poland – Analysis with a VAR Model," FindEcon Chapters: Forecasting Financial Markets and Economic Decision-Making, in: Władysław Milo & Piotr Wdowiński (ed.), Acta Universitatis Lodziensis. Folia Oeconomica nr 295/2013 - Financial Markets and Macroprudential Policy, edition 1, volume 127, chapter 2, pages 25-43, University of Lodz.
    4. Kern Alexander, 2012. "Summing Up and the Challenges Ahead," Chapters, in: Kern Alexander & Rahul Dhumale (ed.), Research Handbook on International Financial Regulation, chapter 20, Edward Elgar Publishing.
    5. Morrison, Alan & Lóránth, Gyöngyi, 2009. "Internal Reporting Systems, Compensation Contracts, and Bank Regulation," CEPR Discussion Papers 7155, C.E.P.R. Discussion Papers.
    6. Miguel A. Segoviano, 2006. "Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing Under Data-Restricted Environments," IMF Working Papers 2006/283, International Monetary Fund.
    7. Morrison, Alan & Lóránth, Gyöngyi, 2009. "Internal Reporting Systems, Compensation Contracts and Bank Regulation," CEPR Discussion Papers 7179, C.E.P.R. Discussion Papers.
    8. International Monetary Fund, 2007. "Denmark: Financial Sector Assessment Program: Technical Note: Stress Testing," IMF Staff Country Reports 2007/125, International Monetary Fund.
    9. Charles Goodhart & Boris Hofmann & Miguel Segoviano, 2004. "Bank Regulation and Macroeconomic Fluctuations," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 20(4), pages 591-615, Winter.
    10. Kern Alexander & Rahul Dhumale (ed.), 2012. "Research Handbook on International Financial Regulation," Books, Edward Elgar Publishing, number 3748.

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