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Do capital buffers mitigate volatility of bank lending? A simulation study

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  • Heid, Frank
  • Krüger, Ulrich

Abstract

Critics claim that capital requirements can exacerbate credit cycles by restricting lending in an economic downturn. The introduction of Basel 2, in particular, has led to concerns that risksensitive capital charges are highly correlated with the business cycle. The Basel Committee is contemplating a revision of the Basel Accord by introducing counter-cyclical capital buffers. Others claim that capital buffers are already large enough to absorb fluctuations in credit risk. We address the question of the pro-cyclical effects of capital requirements in a general framework which takes into account banks' potential adjustment strategies. We develop a dynamic model of bank lending behavior and simulate different regulatory frameworks and macroeconomic scenarios. In particular, we address two related questions in our simulation study: How do business fluctuations affect capital requirements and bank lending? To what extent does the capital buffer absorb fluctuations in the level of mimimum required capital? --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2011,03.

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Date of creation: 2011
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Handle: RePEc:zbw:bubdp2:201103

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Keywords: Minimum capital requirements; regulatory capital; capital buffer; cyclical lending; pro-cyclicality;

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  1. Eva Catarineu-Rabell & Patricia Jackson & Dimitrios Tsomocos, 2005. "Procyclicality and the new Basel Accord - banks’ choice of loan rating system," Economic Theory, Springer, Springer, vol. 26(3), pages 537-557, October.
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Cited by:
  1. Lin, Jyh-Horng & Hung, Wei-Ming, 2013. "A barrier option framework for bank interest margin management under anticipatory regret aversion," Economic Modelling, Elsevier, Elsevier, vol. 33(C), pages 794-801.
  2. Tsai, Jeng-Yan, 2013. "Optimal bank interest margins under capital regulation in a call-option utility framework," Economic Modelling, Elsevier, Elsevier, vol. 31(C), pages 557-565.
  3. Tsai, Jeng-Yan, 2013. "Bank interest margin management based on a path-dependent Cobb–Douglas utility framework," Economic Modelling, Elsevier, Elsevier, vol. 35(C), pages 751-762.

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