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Capital requirements, business loans, and business cycles: an empirical analysis of the standardized approach in the new Basel Capital Accord

  • Seth B. Carpenter
  • William Whitesell
  • Egon Zakrajsek

In the current regulatory framework, capital requirements are based on risk-weighted assets, but all business loans carry a uniform risk weight, irrespective of variations in credit risk. The proposed new Capital Accord of the Bank for International Settlements provides for a greater sensitivity of capital requirements to credit risk, raising the question of whether, and to what extent, the new capital standards will intensify business cycles. In this paper, we evaluate the potential cyclical effects of the "standardized approach" to risk evaluation in the new Accord, which involves the ratings of external agencies. We combine Moody's data on changes in U.S. borrowers' credit ratings since 1970 with estimates of the risk profile of business loans at commercial banks from the Survey of Terms of Business Lending, and also a risk profile estimated by Treacy and Carey (1998). We find that the level of required capital against business loans would be noticeably lower under the new Accord compared with the current regime. We do not find evidence of any substantial additional cyclicality in required capital levels under the standardized approach of the new Accord relative to the current regime.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-48.

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Date of creation: 2001
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Handle: RePEc:fip:fedgfe:2001-48
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  1. Mark Gertler & Simon Gilchrist, 1993. "The role of credit market imperfections in the monetary transmission mechanism: arguments and evidence," Finance and Economics Discussion Series 93-5, Board of Governors of the Federal Reserve System (U.S.).
  2. Claudio Borio & Craig Furfine & Philip Lowe, 2001. "Procyclicality of the financial system and financial stability: issues and policy options," BIS Papers chapters, in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 1-57 Bank for International Settlements.
  3. Cleveland, William S. & Devlin, Susan J. & Grosse, Eric, 1988. "Regression by local fitting : Methods, properties, and computational algorithms," Journal of Econometrics, Elsevier, vol. 37(1), pages 87-114, January.
  4. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  5. Thomas F. Brady & William B. English & William R. Nelson, 1998. "Recent changes to the Federal Reserve's survey of terms of business lending," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Aug, pages 604-615.
  6. Blum, Jurg & Hellwig, Martin, 1995. "The macroeconomic implications of capital adequacy requirements for banks," European Economic Review, Elsevier, vol. 39(3-4), pages 739-749, April.
  7. Altman, Edward I. & Saunders, Anthony, 2001. "An analysis and critique of the BIS proposal on capital adequacy and ratings," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 25-46, January.
  8. Craig Furfine, 2001. "Bank Portfolio Allocation: The Impact of Capital Requirements, Regulatory Monitoring, and Economic Conditions," Journal of Financial Services Research, Springer, vol. 20(1), pages 33-56, September.
  9. William B. English & William R. Nelson, 1998. "Bank risk rating of business loans," Finance and Economics Discussion Series 1998-51, Board of Governors of the Federal Reserve System (U.S.).
  10. Joseph G. Haubrich & Paul Wachtel, 1993. "Capital requirements and shifts in commercial bank portfolios," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 2-15.
  11. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
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