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How Do Bank Capital and Capital Adequacy Regulation Affect the Monetary Transmission Mechanism?

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  • Misa Tanaka

Abstract

This paper analyzes the effect of bank capital adequacy regulation on the monetary transmission mechanism. Using a general equilibrium framework and a representative bank, the model demonstrates that the monetary transmission mechanism is weakened if banks are poorly capitalized, or if the capital adequacy requirement is stringent. The paper also assesses the impact of the New Basel Accord (Basel II), and argues that a rise in credit risk may lead to a sharper loan contraction under this new regime. Moreover, it predicts that Basel II may reduce the effectiveness of monetary policy as a tool for stimulating output during recessions.

Suggested Citation

  • Misa Tanaka, 2002. "How Do Bank Capital and Capital Adequacy Regulation Affect the Monetary Transmission Mechanism?," CESifo Working Paper Series 799, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_799
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    References listed on IDEAS

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    Cited by:

    1. Li Ma & Tsangyao Chang & Chien-Chiang Lee, 2016. "Reserve Requirement Policy, Bond Market, and Transmission Effect," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 66-85, June.
    2. Agénor, Pierre-Richard & Pereira da Silva, Luiz A., 2012. "Cyclical effects of bank capital requirements with imperfect credit markets," Journal of Financial Stability, Elsevier, vol. 8(1), pages 43-56.
    3. Franz R. Hahn, 2003. "The New Basel Capital Accord (Basel II) from a Macroeconomic Point of View," Austrian Economic Quarterly, WIFO, vol. 8(2), pages 51-63, June.
    4. Ines Drumond, 2009. "Bank Capital Requirements, Business Cycle Fluctuations And The Basel Accords: A Synthesis," Journal of Economic Surveys, Wiley Blackwell, vol. 23(5), pages 798-830, December.
    5. Magdalena Redo, 2015. "The importance of prudential regulations in the process of transmitting monetary policy to economy," Copernican Journal of Finance & Accounting, Uniwersytet Mikolaja Kopernika, vol. 4(2), pages 145-158.
    6. Borio, Claudio & Zhu, Haibin, 2012. "Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?," Journal of Financial Stability, Elsevier, vol. 8(4), pages 236-251.
    7. Annalisa Bucalossi & Antonio Scalia, 2016. "Leverage ratio, central bank operations and repo market," Questioni di Economia e Finanza (Occasional Papers) 347, Bank of Italy, Economic Research and International Relations Area.
    8. David VanHoose, 2006. "Bank Behavior Under Capital Regulation: What Does The Academic Literature Tell Us?," NFI Working Papers 2006-WP-04, Indiana State University, Scott College of Business, Networks Financial Institute.
    9. Ines Drumond & José Jorge, 2009. "Basel II Capital Requirements, Firms' Heterogeneity, and the Business Cycle," FEP Working Papers 307, Universidade do Porto, Faculdade de Economia do Porto.
    10. Yilmaz, Ensar, 2009. "Capital accumulation and regulation," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(3), pages 760-771, August.
    11. Kopecky, Kenneth J. & VanHoose, David, 2006. "Capital regulation, heterogeneous monitoring costs, and aggregate loan quality," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2235-2255, August.
    12. Grégory Levieuge, 2005. "Politique monétaire et prix d'actifs," Revue de l'OFCE, Presses de Sciences-Po, vol. 93(2), pages 317-355.
    13. David VanHoose, 2008. "Bank Capital Regulation, Economic Stability, and Monetary Policy: What Does the Academic Literature Tell Us?," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 36(1), pages 1-14, March.
    14. Du, Chuan & Miles, David K, 2014. "Interaction Between Monetary Policy and Regulatory Capital Requirements," CEPR Discussion Papers 10200, C.E.P.R. Discussion Papers.
    15. Grégory Levieuge, 2004. "La neutralisation des mouvements et de l'impact des prix d'actifs doit-elle être du ressort de la politique monétaire ?," Revue d'Économie Financière, Programme National Persée, vol. 74(1), pages 253-284.
    16. Roy Zilberman, 2012. "Supply Shocks and the Cyclical Behaviour of Bank Lending Rates under the Basel Accords," Centre for Growth and Business Cycle Research Discussion Paper Series 161, Economics, The Univeristy of Manchester.
    17. Xiong, Qiyue, 2013. "The role of the bank lending channel and impacts of stricter capital requirements on the Chinese banking industry," BOFIT Discussion Papers 7/2013, Bank of Finland, Institute for Economies in Transition.

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