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Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy


  • Segoviano, Miguel A.
  • Lowe, Philip


The concept of risk-based capital requirements enjoys widespread support. Effective implementation, however, requires that risk be measured accurately both across borrowers and across time. Under the New Capital Accord, the cornerstone of this risk measurement process is the rating of the borrower. In this paper we use the ratings assigned by individual Mexican banks to examine how measured credit risk for these banks has changed since the financial crisis in the mid-1990s. We then examine the implications of these changes in risk for regulatory capital under the proposed changes to the Basel Capital Accord. We find that measured risk increased after the crisis and then fell as the recovery took hold. In turn, despite the limitations of the data, we find that the proposed internal ratings-based approach would have generated large swings in regulatory capital requirements over the second half of the 1990s, with required capital increasing significantly in the aftermath of the crisis, and then falling as the economy recovered. Looking forward, if movements in actual bank capital were to show this same cyclical variation, then business cycle fluctuations might be amplified by developments in the banking industry.

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  • Segoviano, Miguel A. & Lowe, Philip, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," LSE Research Online Documents on Economics 24948, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:24948

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    References listed on IDEAS

    1. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
    2. Gordy, Michael B., 2000. "A comparative anatomy of credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 119-149, January.
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    Cited by:

    1. C. A. E. Goodhart & Miguel A. Segoviano Basurto & Boris Hofmann, 2006. "Default, Credit Growth, and Asset Prices," IMF Working Papers 06/223, International Monetary Fund.
    2. Claudio Borio, 2011. "Rediscovering the Macroeconomic Roots of Financial Stability Policy: Journey, Challenges, and a Way Forward," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 87-117, December.
    3. Athanasoglou, Panayiotis P. & Daniilidis, Ioannis & Delis, Manthos D., 2014. "Bank procyclicality and output: Issues and policies," Journal of Economics and Business, Elsevier, vol. 72(C), pages 58-83.
    4. Markus Behn & Rainer Haselmann & Paul Wachtel, 2016. "Procyclical Capital Regulation and Lending," Journal of Finance, American Finance Association, vol. 71(2), pages 919-956, April.
    5. C. A. E. Goodhart & Miguel A. Segoviano Basurto, 2015. "Optimal Bank Recovery," IMF Working Papers 15/217, International Monetary Fund.
    6. Raupach, Peter, 2015. "Calculating trading book capital: Is risk separation appropriate?," Discussion Papers 19/2015, Deutsche Bundesbank.
    7. Miguel A. Segoviano Basurto, 2006. "Portfolio Credit Risk and Macroeconomic Shocks; Applications to Stress Testing Under Data-Restricted Environments," IMF Working Papers 06/283, International Monetary Fund.
    8. Sebastián Nieto Parra, 2005. "The Macroeconomic Implications of the New Banking Capital Regulation in Emerging Markets: A Duopoly Model Adapted to Risk-Averse Banks," Sciences Po publications info:hdl:2441/810, Sciences Po.
    9. Haibin Zhu, 2007. "Capital regulation and banks' financial decisions," BIS Working Papers 232, Bank for International Settlements.
    10. Anatoly Peresetsky & Alexandr Karminsky & Sergei Golovan, 2011. "Probability of default models of Russian banks," Economic Change and Restructuring, Springer, vol. 44(4), pages 297-334, November.
    11. Benford, James & Nier, Erlend, 2007. "Financial Stability Paper No 3: Monitoring Cyclicality of Basel II Capital Requirements," Bank of England Financial Stability Papers 3, Bank of England.
    12. Пересецкий А.А., 2007. "Методы Оценки Вероятности Дефолта Банков," Журнал Экономика и математические методы (ЭММ), Центральный Экономико-Математический Институт (ЦЭМИ), vol. 43(3), июль.
    13. Griffith-Jones, Stephany & Ocampo, José Antonio, 2003. "What progress on international financial reform? why so limited?," Sede de la CEPAL en Santiago (Estudios e Investigaciones) 34941, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL).
    14. Ali, Syed Babar, 2012. "Quality of Internal Risk Rating Frameworks at Commercial Banks in Pakistan," MPRA Paper 55117, University Library of Munich, Germany.

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    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance
    • J1 - Labor and Demographic Economics - - Demographic Economics


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