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Pro-cyclicality of capital regulation: is it a problem? How to fix it?

Author

Listed:
  • Paolo Angelini

    (Banca d'Italia)

  • Andrea Enria

    (Banca d'Italia)

  • Stefano Neri

    (Banca d'Italia)

  • Fabio Panetta

    (Banca d'Italia)

  • Mario Quagliariello

    (Banca d'Italia)

Abstract

We use a macroeconomic euro area model with a bank sector to study the pro-cyclical effect of the capital regulation, focusing on the extra pro-cyclicality induced by Basel II over Basel I. Our results suggest that this incremental effect is modest. We also find that regulators could offset the extra pro-cyclicality by a countercyclical capital-requirements policy. Our results also suggest that banks may have incentives to accumulate countercyclical capital buffers, making this policy less relevant, but this finding is depends on the type of economic shock posited. We also survey different policy options for dealing with procyclicality and discuss the pros and cons of the measures available.

Suggested Citation

  • Paolo Angelini & Andrea Enria & Stefano Neri & Fabio Panetta & Mario Quagliariello, 2010. "Pro-cyclicality of capital regulation: is it a problem? How to fix it?," Questioni di Economia e Finanza (Occasional Papers) 74, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:opques:qef_74_10
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    1. Paolo Angelini & Laurent Clerc & Vasco Cúrdia & Leonardo Gambacorta & Andrea Gerali & Alberto Locarno & Roberto Motto & Werner Roeger & Skander Van den Heuvel & Jan Vlček, 2015. "Basel III: Long-term Impact on Economic Performance and Fluctuations," Manchester School, University of Manchester, vol. 83(2), pages 217-251, March.
    2. Fajar Oktiyanto & Harmanta & Nur M. Adhi Purwanto & Aditya Rachmanto, 2014. "Monetary Macroprudential Policy Mix under Financial Frictions Mechanism with DSGE Model," EcoMod2014 6840, EcoMod.
    3. Hodbod, Alexander & Huber, Stefanie J. & Vasilev, Konstantin, 2020. "Sectoral risk-weights and macroprudential policy," Journal of Banking & Finance, Elsevier, vol. 112(C).
    4. Katuala, Hénock M., 2021. "Frictions financières et Dynamique macroéconomique : Examen des régularités cycliques," Dynare Working Papers 66, CEPREMAP.
    5. Guangling Dave Liu & Nkhahle E. Seeiso, 2011. "Business Cycle and Bank Capital Regulation: Basel II Procyclicality," Working Papers 221, Economic Research Southern Africa.
    6. Rafael Repullo & Javier Suarez, 2013. "The Procyclical Effects of Bank Capital Regulation," The Review of Financial Studies, Society for Financial Studies, vol. 26(2), pages 452-490.
    7. Michał Brzoza‐Brzezina & Marcin Kolasa, 2013. "Bayesian Evaluation of DSGE Models with Financial Frictions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(8), pages 1451-1476, December.
    8. Leonardo Nogueira Ferreira & Márcio Issao Nakane, 2018. "Macroprudential policy in a DSGE model: anchoring the countercyclical capital buffer," Economics Bulletin, AccessEcon, vol. 38(4), pages 2345-2352.
    9. Nobili, Andrea & Zollino, Francesco, 2017. "A structural model for the housing and credit market in Italy," Journal of Housing Economics, Elsevier, vol. 36(C), pages 73-87.
    10. Yaprak Tavman, 2015. "A comparative analysis of macroprudential policies," Oxford Economic Papers, Oxford University Press, vol. 67(2), pages 334-355.
    11. Falagiarda, Matteo & Saia, Alessandro, 2017. "Credit, Endogenous Collateral and Risky Assets: A DSGE Model," International Review of Economics & Finance, Elsevier, vol. 49(C), pages 125-148.
    12. Rainer Baule & Christian Tallau, 2016. "Revisiting Basel risk weights: cross-sectional risk sensitivity and cyclicality," Journal of Business Economics, Springer, vol. 86(8), pages 905-931, November.
    13. Liu, Guangling & Molise, Thabang, 2019. "Housing and credit market shocks: Exploring the role of rule-based Basel III counter-cyclical capital requirements," Economic Modelling, Elsevier, vol. 82(C), pages 264-279.
    14. Malgorzata Olszak, 2015. "The phenomenon of excessive procyclicality of the financial sector from the perspective of macroprudential policy – sources, methods of reduction and their basic limitations (Zjawisko nadmiernej procy," Problemy Zarzadzania, University of Warsaw, Faculty of Management, vol. 13(55), pages 72-96.
    15. David Martinez-Miera & Rafael Repullo, 2019. "Monetary Policy, Macroprudential Policy, and Financial Stability," Annual Review of Economics, Annual Reviews, vol. 11(1), pages 809-832, August.
    16. Karmakar, Sudipto, 2016. "Macroprudential regulation and macroeconomic activity," Journal of Financial Stability, Elsevier, vol. 25(C), pages 166-178.
    17. Simona Malovana, 2018. "The Pro-Cyclicality of Risk Weights for Credit Exposures in the Czech Republic," Working Papers 2018/12, Czech National Bank.
    18. Paolo Angelini & Stefano Neri & Fabio Panetta, 2011. "Monetary and macroprudential policies," Temi di discussione (Economic working papers) 801, Bank of Italy, Economic Research and International Relations Area.
    19. Torsten Wezel & Mr. Jorge A Chan-Lau & Mr. Francesco Columba, 2012. "Dynamic Loan Loss Provisioning: Simulationson Effectiveness and Guide to Implementation," IMF Working Papers 2012/110, International Monetary Fund.
    20. Stijn Claessens, 2015. "An Overview of Macroprudential Policy Tools," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 397-422, December.
    21. Brzoza-Brzezina, Michał & Kolasa, Marcin & Makarski, Krzysztof, 2013. "The anatomy of standard DSGE models with financial frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 32-51.
    22. Guangling Liu & Thabang Molise, 2018. "Is Basel III counter-cyclical: The case of South Africa?," Working Papers 10/2018, Stellenbosch University, Department of Economics.
    23. Liu, Guangling (Dave) & Seeiso, Nkhahle E., 2012. "Basel II procyclicality: The case of South Africa," Economic Modelling, Elsevier, vol. 29(3), pages 848-857.

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    More about this item

    Keywords

    Basel accord; pro-cyclicality;

    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
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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