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Will Basel II Lead to a Specialization of Unsophisticated Banks on High‐Risk Borrowers?

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  • Bertrand Rime

Abstract

The stability of the banking sector is an essential precondition for a well‐functioning economy. Enhancing this stability was one of the main motivations for the elaboration of the new capital adequacy framework, Basel II. The present paper examines the impact of Basel II on risk allocation in the banking sector and its implications for bank capital adequacy. Basel II introduces a two‐layer framework for the calculation of the capital requirement for credit risk: (i) a very risk‐sensitive internal ratings‐based (IRB) approach that will be used by large sophisticated banks and (ii) a standardized approach, much less risk sensitive, which will be used by smaller, less sophisticated banks. We show that because the two bank types compete in the loan market, Basel II may induce sophisticated banks to specialize on low‐risk borrowers and unsophisticated banks to specialize on high‐risk borrowers. As a consequence, we may face a trade‐off between the capital adequacy of the two types of banks, with an ambiguous net effect on financial stability: the risk sensitivity of the IRB approach improves the capital adequacy of sophisticated banks, but it deteriorates the capital adequacy of unsophisticated banks, as their increased risk taking is not appropriately reflected by the standardized capital requirement.

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  • Bertrand Rime, 2005. "Will Basel II Lead to a Specialization of Unsophisticated Banks on High‐Risk Borrowers?," International Finance, Wiley Blackwell, vol. 8(1), pages 29-55, March.
    • Handle: RePEc:bla:intfin:v:8:y:2005:i:1:p:29-55
    DOI: 10.1111/j.1367-0271.2005.00150.x
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    2. Tyrone Lin & Chia-Chi Lee & Yu-Chuan Kuan, 2013. "The optimal operational risk capital requirement by applying the advanced measurement approach," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 21(1), pages 85-101, January.
    3. Benetton, Matteo & Eckley, Peter & Garbarino, Nicola & Kirwin, Liam & Latsi, Georgia, 2021. "Capital requirements and mortgage pricing: Evidence from Basel II," Journal of Financial Intermediation, Elsevier, vol. 48(C).
    4. Zins, Alexandra & Weill, Laurent, 2017. "Islamic banking and risk: The impact of Basel II," Economic Modelling, Elsevier, vol. 64(C), pages 626-637.
    5. Clovis Rugemintwari, 2011. "The Leverage Ratio as a Bank Discipline Device," Revue économique, Presses de Sciences-Po, vol. 62(3), pages 479-490.
    6. Clovis Rugemintwari & Alain Sauviat & Amine Tarazi, 2012. "Bâle 3 et la réhabilitation du ratio de levier des banques. Pourquoi et comment ?," Revue économique, Presses de Sciences-Po, vol. 63(4), pages 809-820.
    7. Tuuli, Saara, 2019. "Model-based regulation and firms' access to finance," Bank of Finland Research Discussion Papers 4/2019, Bank of Finland.
    8. Tuuli, Saara, 2019. "Model-based regulation and firms' access to finance," Research Discussion Papers 4/2019, Bank of Finland.
    9. Eva Schliephake & Roland Kirstein, 2013. "Strategic Effects of Regulatory Capital Requirements in Imperfect Banking Competition," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 675-700, June.
    10. Hege, Ulrich & Feess, Eberhard, 2007. "Basel II and the Value of Bank Differentiation," HEC Research Papers Series 879, HEC Paris.
    11. Dietrich, Diemo & Hauck, Achim, 2014. "Bank capital regulation, loan contracts, and corporate investment," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(2), pages 230-241.
    12. Dal Borgo, Mariela, 2022. "Internal models for deposits: Effects on banks' capital and interest rate risk of assets," Journal of Banking & Finance, Elsevier, vol. 135(C).
    13. repec:zbw:bofrdp:2019_004 is not listed on IDEAS

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