Evaluating the influence of the internal ratings-based approach on bank lending in Japan

The capital adequacy requirement of banks shifted in March, 2007 from Basel I to Basel II. In Basel II, exact measurement of credit risk is adopted, and banks choose between a standardized approach (SA) and an internal ratings-based approach (IRBA). In general, the IRBA is a more risk-sensitive capital requirement measurement than the SA and Basel I. Theoretical modeling in related literatures implies that since the IRBA depends on the probability of default, a downturn implies a higher capital requirement, meaning that the IRBA is pro-cyclical to the business cycle. The purpose of this paper is to verify the effects of the IRBA on bank lending through empirical analysis. Although the empirical analysis here cannot confirm the pro-cyclicality of the IRBA, it does allow the proposal of a benchmark for the effects of this approach. The effect we estimate is the Average Treatment Effect on the Treated (ATT), and the estimation method adopted is difference-in-difference propensity score matching (DID-PSM). Using this method, we can confirm the real effects of the IRBA. The results are that in 2006-2007 when bank balance-sheets were favorable, the ATT are negative, but all these are insignificant, on the other hand, in 2006-2008 when the balance-sheets were infuluenced by the subprime-loan crisis, the ATT are negative and significant, and smaller than it in 2006-2008. Thus, we cannot say that the IRBA has the pro-cyclicality exactly.