The Disappearance of Bank Capital Pro-Cyclicality in Emerging and Low-Income Economies under Basel III

This paper analyzes the cyclicality of bank capital ratios in emerging and low-income economies over the period 2004–2024, with particular attention to developments following the introduction of Basel III. Using a panel of 1,185 banks across 122 countries, we study how economic growth affects banks’ capital ratios and whether this relationship varies across regions, income groups, and levels of capitalization. Unlike risk-weighted measures, leverage-based capital ratios provide a clearer assessment of banks’ capacity to absorb shocks and support credit supply during downturns. Our findings indicate that prior to 2014, capital ratios were broadly procyclical, but in the last decade this relationship has weakened or reversed in many emerging economies. Banks with higher capital buffers exhibit the strongest countercyclical behavior, reflecting an enhanced ability to sustain lending under adverse conditions, while banks operating near regulatory minima remain largely acyclical, constrained by regulatory requirements. Regional heterogeneity is pronounced, with Latin America, developing Asia, and the Middle East showing the most substantial improvements. The results suggest that the principles underlying modern macroprudential regulation, particularly the accumulation of countercyclical capital in expansions to support lending in downturns, are increasingly influencing bank behavior, even in jurisdictions where Basel III has not been fully implemented.