Mitigating the Procyclicality of Basel II
This paper compares alternative procedures to mitigate the procyclicality of the new risk-sensitive bank capital regulation (Basel II). We estimate a model of the probabilities of default (PDs) of Spanish firms during the period 1987-2008, and use the estimated PDs to compute the corresponding series of Basel II capital requirements per unit of loans. These requirements move significantly along the business cycle, ranging from 7.6% (in 2006) to 11.9% (in 1993). The comparison of the different procedures is based on the criterion of minimizing the root mean square deviations of each smoothed series with respect to the Hodrick-Prescott trend of the original series. The results show that the best procedures are either to smooth the inputs of the Basel II formula by using through-the-cycle PDs or to smooth the output with a multiplier based on GDP growth. Our discussion concludes that the latter is better in terms of simplicity, transparency, and consistency with banks’ risk pricing and risk management systems. For the portfolio of Spanish commercial and industrial loans and a 45% loss given default (LGD), the multiplier would amount to a 6.5% surcharge for each standard deviation in GDP growth. The surcharge would be significantly higher with cyclically-varying LGDs.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
|Date of creation:||Jul 2009|
|Date of revision:|
|Contact details of provider:|| Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.|
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
|Order Information:|| Email: |
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Hancock, Diana & Laing, Andrew J. & Wilcox, James A., 1995. "Bank capital shocks: Dynamic effects on securities, loans, and capital," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 661-677, June.
- Gabriel Jiménez & Jesús Saurina, 2006. "Credit Cycles, Credit Risk, and Prudential Regulation," International Journal of Central Banking, International Journal of Central Banking, vol. 2(2), May.
- Gambacorta, Leonardo & Mistrulli, Paolo Emilio, 2004. "Does bank capital affect lending behavior?," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 436-457, October.
- Jesus, Saurina & Gabriel, Jimenez, 2006. "Credit Cycles, Credit Risk, and Prudential Regulation," MPRA Paper 718, University Library of Munich, Germany.
- Moyer, Susan E., 1990. "Capital adequacy ratio regulations and accounting choices in commercial banks," Journal of Accounting and Economics, Elsevier, vol. 13(2), pages 123-154, July.
- Gordy, Michael B. & Howells, Bradley, 2006. "Procyclicality in Basel II: Can we treat the disease without killing the patient?," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 395-417, July.
- Daniel Perez & Vicente Salas-Fumas & Jesus Saurina, 2008. "Earnings and Capital Management in Alternative Loan Loss Provision Regulatory Regimes," European Accounting Review, Taylor & Francis Journals, vol. 17(3), pages 423-445.
- Rafael Repullo & Javier Suarez, 2008.
"The Procyclical Effects Of Basel Ii,"
- Berger, Allen N. & Udell, Gregory F., 1990.
"Collateral, loan quality and bank risk,"
Journal of Monetary Economics,
Elsevier, vol. 25(1), pages 21-42, January.
- Ben S. Bernanke & Cara S. Lown, 1991. "The Credit Crunch," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(2), pages 205-248.
- Joe Peek & Eric S. Rosengren, 1993.
"Bank regulation and the credit crunch,"
93-2, Federal Reserve Bank of Boston.
- Jesús Saurina & Carlos Trucharte, 2007. "An Assessment of Basel II Procyclicality in Mortgage Portfolios," Journal of Financial Services Research, Springer, vol. 32(1), pages 81-101, October.
- Jon Frye, 2000. "Depressing recoveries," Emerging Issues, Federal Reserve Bank of Chicago, issue Oct.
- Engelmann, Bernd & Hayden, Evelyn & Tasche, Dirk, 2003. "Measuring the Discriminative Power of Rating Systems," Discussion Paper Series 2: Banking and Financial Studies 2003,01, Deutsche Bundesbank, Research Centre.
- Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
- Scholes, Myron S & Wilson, G Peter & Wolfson, Mark A, 1990. "Tax Planning, Regulatory Capital Planning, and Financial Reporting Strategy for Commercial Banks," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 625-50.
- Ahmed, Anwer S. & Takeda, Carolyn & Thomas, Shawn, 1999. "Bank loan loss provisions: a reexamination of capital management, earnings management and signaling effects," Journal of Accounting and Economics, Elsevier, vol. 28(1), pages 1-25, November.
- Kim, Myung-Sun & Kross, William, 1998. "The impact of the 1989 change in bank capital standards on loan loss provisions and loan write-offs," Journal of Accounting and Economics, Elsevier, vol. 25(1), pages 69-99, February.
- Joe Peek & Eric Rosengren, 1993.
"The Capital Crunch: Neither A Borrower Nor A Lender Be,"
Boston College Working Papers in Economics
243, Boston College Department of Economics.
- Peek, Joe & Rosengren, Eric, 1995. "The Capital Crunch: Neither a Borrower nor a Lender Be," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 625-38, August.
- Joe Peek & Eric S. Rosengren, 1991. "The capital crunch: neither a borrower nor a lender be," Working Papers 91-4, Federal Reserve Bank of Boston.
- Hancock, Diana & Wilcox, James A., 1994. "Bank Capital, Loan Delinquencies, and Real Estate Lending," Journal of Housing Economics, Elsevier, vol. 3(2), pages 121-146, June.
- Jesús Saurina & Carlos Trucharte, 2007. "An assessment of Basel II procyclicality in mortgage portfolios," Working Papers 0712, Banco de España;Working Papers Homepage.
When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:7382. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()The email address of this maintainer does not seem to be valid anymore. Please ask to update the entry or send us the correct email address
If references are entirely missing, you can add them using this form.