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Bank capital shocks and countercyclical requirements: Implications for banking stability and welfare

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  • Bekiros, Stelios
  • Nilavongse, Rachatar
  • Uddin, Gazi Salah

Abstract

This paper incorporates anticipated and unanticipated shocks to bank capital into a DSGE model with a banking sector. We apply this model to study Basel III countercyclical capital requirements and their implications for banking stability and household welfare. We introduce three different countercyclical capital rules. The first countercyclical capital rule responds to credit to output ratio. The second countercyclical rule reacts to deviations of credit to its steady state, and the third rule reacts to credit growth. The second rule proves to be the most effective tool in dampening credit supply, housing demand and household debt as well as in enhancing the banking stability by ensuring that banks have higher bank capital and capital to asset ratio. After conducting a welfare analysis we find that the second rule outranks the other ones followed by the first rule, the baseline and the third rule respectively in terms of welfare accumulation.

Suggested Citation

  • Bekiros, Stelios & Nilavongse, Rachatar & Uddin, Gazi Salah, 2018. "Bank capital shocks and countercyclical requirements: Implications for banking stability and welfare," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 315-331.
    • Handle: RePEc:eee:dyncon:v:93:y:2018:i:c:p:315-331
    DOI: 10.1016/j.jedc.2018.01.049
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    2. Wen-Juan Xu & Li-Xin Zhong, 2022. "Market impact shapes competitive advantage of investment strategies in financial markets," PLOS ONE, Public Library of Science, vol. 17(2), pages 1-23, February.
    3. Gebauer, Stefan & Mazelis, Falk, 2023. "Macroprudential regulation and leakage to the shadow banking sector," European Economic Review, Elsevier, vol. 154(C).
    4. Bekiros, Stelios & Nilavongse, Rachatar & Uddin, Gazi Salah, 2020. "Expectation-driven house prices and debt defaults: The effectiveness of monetary and macroprudential policies," Journal of Financial Stability, Elsevier, vol. 49(C).
    5. Gulan, Adam & Jokivuolle, Esa & Verona, Fabio, 2022. "Optimal bank capital requirements: What do the macroeconomic models say?," BoF Economics Review 2/2022, Bank of Finland.
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    8. Solikin M. Juhro & Denny Lie, 2024. "Monetary-macroprudential policy mix and financial system procyclicality: Should macroprudential policy be countercyclical or procyclical?," Working Papers 2024-22, University of Sydney, School of Economics.
    9. Giorgio Massari & Patrizio Tirelli, 2022. "Whither Liquidity Shocks?," Working Papers 502, University of Milano-Bicocca, Department of Economics.
    10. Xinping Zhang & Yimeng Zhang & Yunchan Zhu, 2021. "COVID-19 Pandemic, Sustainability of Macroeconomy, and Choice of Monetary Policy Targets: A NK-DSGE Analysis Based on China," Sustainability, MDPI, vol. 13(6), pages 1-20, March.
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    13. Dück, Alexander & Verona, Fabio, 2023. "Robust frequency-based monetary policy rules," IMFS Working Paper Series 180, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
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    More about this item

    Keywords

    Banking stability; Basel III; Capital requirements; News shocks; Welfare analysis;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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