Macroeconomic dynamics of the output floor

We assess the macroeconomic effects of the output floor, a new regulatory constraint introduced as part of the Basel III framework. The output floor is designed to provide a backstop against excessively low risk-weighted assets (RWA) modelled by banks relative to the riskiness of the underlying exposures. Our model shows that it counteracts the downward pressure on modelled RWA during economic expansions and, in turn, reduces the cyclicality of risk-weighted capital requirements. This mitigates increases in the credit-to-GDP ratio and supports the objectives of the macroprudential authority. Our analysis also uncovers important sectoral effects. Estimating the model for the UK economy, we find that during an expansion the output floor dampens the growth of mortgage lending but amplifies the expansion of lending to firms, although the latter effect is more than offset by the former.