The economic costs of higher capital and liquidity requirements: Impact on lending rate and GDP

This is an analysis of the economic costs of the Basel III capital and liquidity requirements and is the first of its kind for Denmark. Applying an established methodology, higher requirements are first translated into an impact on a representative bank’s lending rate. Next, the impact is used as an input in the macroeconometric model for the Danish economy, ADAM. As a particular contribution, the analysis explicitly takes into account the change in requirements over both the Basel II and Basel III regulatory regimes by including the transition to Basel II risk weighting approaches, including the Internal Rating Based Models. The impact of the so-called Net Stable Funding Ratio (NSFR) is also estimated. Results show that increasing the capital ratio by 1 pct. point will raise the lending rate by a maximum of 6 basis points. The impact from the NSFR is estimated to result in a 16 basis points increase in the lending rate but subject to greater uncertainty. Results point to relatively modest macroeconomic costs from Basel III with an estimated short to medium term negative impact on GDP of 0.29 pct. and a long term impact of 0.09 pct. Noticeably, the NSFR accounts for more than half of the estimated costs.