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Basel II procyclicality: The case of South Africa

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  • Liu, Guangling (Dave)
  • Seeiso, Nkhahle E.

Abstract

This paper studies the impact of bank capital regulation on business cycle fluctuations. In particular, we study the procyclical nature of Basel II claimed in the literature. To do so, we adopt the Bernanke et al. (1999) “financial accelerator” model (BGG), to which we augment a banking sector. We first study the impact of a negative shock to entrepreneurs' net worth and a positive monetary policy shock on business cycle fluctuations. We then look at the impact of a negative net worth shock on business cycle fluctuations when the minimum capital requirement increases from 8 percent to 12 percent. Our comparison studies between the augmented BGG model with Basel I bank regulation and the one with Basel II bank regulation suggest that, in the presence of credit market frictions and bank capital regulation, the liquidity premium effect further amplifies the financial accelerator effect through the external finance premium channel, which, in turn, contributes to the amplification of Basel II procyclicality. Moreover, under Basel II bank regulation, in response to a negative net worth shock, the liquidity premium and the external finance premium rise much more if the minimum bank capital requirement increases, which, in turn, amplify the response of real variables. Finally, small adjustments in monetary policy can result in stronger response in the real economy, in the presence of Basel II bank regulation in particular, which is undesirable.

Suggested Citation

  • Liu, Guangling (Dave) & Seeiso, Nkhahle E., 2012. "Basel II procyclicality: The case of South Africa," Economic Modelling, Elsevier, vol. 29(3), pages 848-857.
  • Handle: RePEc:eee:ecmode:v:29:y:2012:i:3:p:848-857
    DOI: 10.1016/j.econmod.2011.10.015
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    References listed on IDEAS

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    Cited by:

    1. R. P. Agenor & K. Alper & L. Pereira da Silva, 2013. "Capital Regulation, Monetary Policy, and Financial Stability," International Journal of Central Banking, International Journal of Central Banking, vol. 9(3), pages 198-243, September.
    2. Tayler, William & Zilberman, Roy, 2014. "Macroprudential Regulation and the Role of Monetary Policy," Dynare Working Papers 37, CEPREMAP.
    3. Drumond, Inês & Jorge, José, 2013. "Loan interest rates under risk-based capital requirements: The impact of banking market structure," Economic Modelling, Elsevier, vol. 32(C), pages 602-607.
    4. Tayler, William J. & Zilberman, Roy, 2016. "Macroprudential regulation, credit spreads and the role of monetary policy," Journal of Financial Stability, Elsevier, vol. 26(C), pages 144-158.

    More about this item

    Keywords

    Business cycle fluctuations; Financial accelerator; Bank capital requirement; Monetary policy;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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