The Procyclical Effects of Bank Capital Regulation

We assess the procyclical effects of bank capital regulation in a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period. Banks anticipate that shocks to their earnings as well as the cyclical position of the economy can impair their capacity to lend in the future and, as a precaution, hold capital buffers. We find that under cyclically-varying risk-based capital requirements (e.g. Basel II) banks hold larger buffers in expansions than in recessions. Yet, these buffers are insufficient to prevent a significant contraction in the supply of credit at the arrival of a recession. We show that cyclical adjustments in the confidence level underlying Basel II can reduce its procyclical effects on the supply of credit without compromising banks’ long-run solvency targets.

[1]  Richard Luger,et al.  Dynamic correlations, estimation risk, and porfolio management during the financial crisis , 2011 .

[2]  Rafael Repullo,et al.  The Countercyclical Capital Buffer of Basel III: A Critical Assessment , 2011 .

[3]  J. Stein,et al.  A Macroprudential Approach to Financial Regulation , 2010 .

[4]  Mario Quagliariello,et al.  Pro-Cyclicality of Capital Regulation: Is it a Problem? How to Fix it? , 2010 .

[5]  Rafael Repullo,et al.  Mitigating the Pro-Cyclicality of Basel II , 2010 .

[6]  Javier Suarez,et al.  The Spanish Crisis: Background and Policy Challenges , 2010 .

[7]  L. Laeven,et al.  Resolution of Banking Crises: The Good, the Bad, and the Ugly , 2010, SSRN Electronic Journal.

[8]  Kevin Moran,et al.  The Role of Bank Capital in the Propagation of Shocks , 2010 .

[9]  Gerard Llobet,et al.  Entrepreneurial Innovation, Patent Protection, and Industry Dynamics , 2010 .

[10]  L. Sessa,et al.  Credit and Banking in a DSGE Model of the Euro Area , 2010 .

[11]  N. Kiyotaki,et al.  Financial Intermediation and Credit Policy , 2010 .

[12]  N. Kiyotaki,et al.  Financial Intermediation and Credit Policy in Business Cycle Analysis , 2010 .

[13]  Mario Quagliariello,et al.  Dynamic Provisioning: Rationale, Functioning, and Prudential Treatment , 2009 .

[14]  D. Scharfstein,et al.  Bank Lending During the Financial Crisis of 2008 , 2009 .

[15]  Markus K. Brunnermeier,et al.  The fundamental principles of financial regulation , 2009 .

[16]  Rafael Repullo,et al.  Mitigating the Procyclicality of Basel II , 2009 .

[17]  Roland Pongou,et al.  A Dynamic Theory of Fidelity Networks with an Application to the Spread of HIV / AIDS , 2009 .

[18]  Ildefonso Méndez,et al.  Promoting permanent employment: lessons from Spain , 2013 .

[19]  Luc Laeven,et al.  Systemic Banking Crises: A New Database , 2008, SSRN Electronic Journal.

[20]  Ildefonso Méndez,et al.  Intergenerational Time Transfers and Internal Migration: Accounting for Low Spatial Mobility in Southern Europe , 2008 .

[21]  Allen N. Berger,et al.  How Do Large Banking Organizations Manage Their Capital Ratios? , 2008 .

[22]  Raghuram G. Rajan,et al.  Rethinking Capital Regulation , 2008 .

[23]  Toni M. Whited,et al.  How Costly Is External Financing? Evidence from a Structural Estimation , 2007 .

[24]  Haibin Zhu.  Capital Regulation and Banks' Financial Decisions , 2007 .

[25]  Jesús Saurina,et al.  An Assessment of Basel II Procyclicality in Mortgage Portfolios , 2007 .

[26]  Danièle Nouy.  High Level Meeting on the Implementation of Basel II and Other Supervisory Priorities Jointly organised by the Financial Stability Institute (FSI) and the Committee of European Banking Supervisors (CEBS) , 2007 .

[27]  Max Bruche,et al.  Recovery rates , default probabilities , and the credit cycle , 2006 .

[28]  Michael B. Gordy,et al.  Procyclicality in Basel II: Can we treat the disease without killing the patient? , 2006 .

[29]  J. Tirole.  The theory of corporate finance , 2006 .

[30]  S. V. D. Heuvel,et al.  The Welfare Cost of Bank Capital Requirements , 2008 .

[31]  S. Koopman,et al.  Empirical credit cycles and capital buffer formation , 2005 .

[32]  Matteo Iacoviello.  House prices, borrowing constraints and monetary policy in the business cycle , 2005 .

[33]  Jussi Keppo,et al.  Optimal Bank Capital with Costly Recapitalization , 2005 .

[34]  Jacob A. Bikker,et al.  Is Bank Capital Procyclical? A Cross-Country Analysis , 2004 .

[35]  Arturo Estrella,et al.  The cyclical behavior of optimal bank capital , 2004 .

[36]  Roberto Serrano,et al.  On Watson's Non-Forcing Contracts and Renegotiation , 2004 .

[37]  Kjersti-Gro Lindquist.  Banks' buffer capital: How important is risk? , 2004 .

[38]  J. Stein,et al.  Cyclical implications of the Basel II capital standards , 2004 .

[39]  Javier Suarez,et al.  LOAN PRICING UNDER BASEL CAPITAL REQUIREMENTS , 2003 .

[40]  Andrea Resti,et al.  The Link between Default and Recovery Rates: Theory, Empirical Evidence and Implications , 2003 .

[41]  D. Tsomocos,et al.  Procyclicality and the new Basel Accord - banks’ choice of loan rating system , 2005 .

[42]  A. Yaron,et al.  Asset Prices and Business Cycles with Costly External Finance , 2002 .

[43]  Michael B. Gordy.  A Risk-Factor Model Foundation for Ratings-Based Bank Capital Rules , 2002 .

[44]  Jesús Saurina,et al.  Are capital buffers pro-cyclical?: Evidence from Spanish panel data , 2002 .

[45]  A. Greenspan.  Cyclicality and Banking Regulation : Remarks at the Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago , 2002 .

[46]  Alan S. Greenspan.  Cyclicality and banking regulation , 2002 .

[47]  C. Goodhart,et al.  An academic response to Basel II , 2001 .

[48]  Luigi Guiso,et al.  Multiple versus Single Banking Relationships: Theory and Evidence , 2000 .

[49]  X. Freixas,et al.  Corporate Finance and the Monetary Transmission Mechanism , 2000 .

[50]  Arnoud Boot.  Relationship Banking: What Do We Know? , 2000 .

[51]  Thomas F. Cooley,et al.  Financial Markets and Firm Dynamics , 1999 .

[52]  Douglas W. Diamond,et al.  A Theory of Bank Capital , 1999 .

[53]  Ernst-Ludwig von Thadden,et al.  Asymmetric Information, Bank Lending and Implicit Contracts : The Winner's Curse , 2004 .

[54]  John R. Graham,et al.  How Big are the Tax Benefits of Debt , 2000 .

[55]  Charles T. Carlstrom,et al.  Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis , 1998 .

[56]  Firms,et al.  Oliver Hart, "Firms, Contracts, and Financial Structure: Clarendon Lectures in Economics" , 1998 .

[57]  J. Tirole,et al.  Financial Intermediation, Loanable Funds, and The Real Sector , 1997 .

[58]  Oliver Hart,et al.  Firms, contracts, and financial structure , 1995 .

[59]  M. Hellwig,et al.  The macroeconomic implications of capital adequacy requirements for banks , 1995 .

[60]  David W. Wilcox,et al.  Monetary Policy and Credit Conditions: Evidence from the Composition of External Finance , 1992 .

[61]  Ben S. Bernanke,et al.  The Credit Crunch , 1991 .

[62]  Steven A. Sharpe.  Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships , 1990 .

[63]  B. Bernanke,et al.  Agency Costs, Net Worth, and Business Fluctuations , 1988 .

[64]  G. Calvo.  Staggered prices in a utility-maximizing framework , 1983 .

[65]  S. Myers.  Determinants of corporate borrowing , 1977 .