IDEAS home Printed from https://ideas.repec.org/a/kap/fmktpm/v19y2005i2p179-200.html
   My bibliography  Save this article

Procyclicality: The Macroeconomic Impact of Risk-Based Capital Requirements

Author

Listed:
  • Bernd Hofmann

Abstract

Recent research on the Basel II capital framework suggests that binding capital requirements may be responsible for bank behaviour which causes procyclical amplifications of the macroeconomic cycle. This paper presents a model of the interrelations between the state of the economy, credit risk, and loan supply to clarify and quantify this effect. Special attention is paid to the fact that both regulatory and economic capital requirements can significantly influence loan supply, provided that they are binding. The model shows that both economic capital, based on a one-factor model, and the regulatory IRB requirements cause more procyclicality than the constant regulatory requirements of the Basel I capital accord. However, the overall impact depends on the interrelation of the regulatory requirements with economic capital. Based on this result, the replacement of the Basel I requirements with risk-sensitive IRB capital requirements boosts procyclicality under most, but not under all conditions. Copyright Swiss Society for Financial Market Research 2005

Suggested Citation

  • Bernd Hofmann, 2005. "Procyclicality: The Macroeconomic Impact of Risk-Based Capital Requirements," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 19(2), pages 179-200, August.
    • Handle: RePEc:kap:fmktpm:v:19:y:2005:i:2:p:179-200
    DOI: 10.1007/s11408-005-3385-1
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s11408-005-3385-1
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s11408-005-3385-1?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Edward I. Altman & Andrea Resti & Andrea Sironi, 2002. "The link between default and recovery rates: effects on the procyclicality of regulatory capital ratios," BIS Working Papers 113, Bank for International Settlements.
    2. Heid, Frank & Porath, Daniel & Stolz, Stéphanie, 2003. "Does capital regulation matter for bank behavior? Evidence for German savings banks," Kiel Working Papers 1192, Kiel Institute for the World Economy (IfW Kiel).
    3. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-1072, June.
    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. 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.
    6. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December.
    7. Estrella, Arturo, 2004. "The cyclical behavior of optimal bank capital," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1469-1498, June.
    8. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    9. Jean-Pierre Zigrand & Jon Danielsson, 2001. "What Happens When You Regulate Risk? Evidence from a Simple Equilibrium Model," FMG Discussion Papers dp393, Financial Markets Group.
    10. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July.
    11. Berger, Allen N. & Udell, Gregory F., 2004. "The institutional memory hypothesis and the procyclicality of bank lending behavior," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 458-495, October.
    12. Cara S. Lown & Donald P. Morgan & Sonali Rohatgi, 2000. "Listening to loan officers: the impact of commercial credit standards on lending and output," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 1-16.
    13. Hans Gersbach & Alexander Lipponer, 2003. "Firm Defaults and the Correlation Effect," European Financial Management, European Financial Management Association, vol. 9(3), pages 361-378, September.
    14. Michael B. Gordy, 2000. "Credit VAR and risk-bucket capital rules: a reconciliation," Proceedings 685, Federal Reserve Bank of Chicago.
    15. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    16. Zhou, Chunsheng, 2001. "An Analysis of Default Correlations and Multiple Defaults," The Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 555-576.
    17. repec:bla:jfinan:v:53:y:1998:i:4:p:1363-1387 is not listed on IDEAS
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Juan Amador & José Gómez-González & Andrés Pabón, 2013. "Loan growth and bank risk: new evidence," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 27(4), pages 365-379, December.
    2. Robert N. Collender & Forrest W. Pafenberg & Robert S. Seiler, Jr., 2010. "Automatic Recapitalization Alternatives," FHFA Staff Working Papers 10-02, Federal Housing Finance Agency.
    3. Marc Ryser & Stefan Denzler, 2009. "Selecting credit rating models: a cross-validation-based comparison of discriminatory power," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 23(2), pages 187-203, June.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Gordy, Michael B. & Howells, Bradley, 2006. "Procyclicality in Basel II: Can we treat the disease without killing the patient?," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 395-417, July.
    2. Linda Allen & Anthony Saunders, 2004. "Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature," Journal of Financial Services Research, Springer;Western Finance Association, vol. 26(2), pages 161-191, October.
    3. Bonfim, Diana, 2009. "Credit risk drivers: Evaluating the contribution of firm level information and of macroeconomic dynamics," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 281-299, February.
    4. Ulrich Erlenmaier & Hans Gersbach, 2014. "Default Correlations in the Merton Model," Review of Finance, European Finance Association, vol. 18(5), pages 1775-1809.
    5. Goetz von Peter, 2004. "Asset Prices and Banking Distress: A Macroeconomic Approach," Finance 0411034, University Library of Munich, Germany.
    6. Koopman, Siem Jan & Lucas, Andre & Klaassen, Pieter, 2005. "Empirical credit cycles and capital buffer formation," Journal of Banking & Finance, Elsevier, vol. 29(12), pages 3159-3179, December.
    7. Umara Noreen & Fizza Alamdar & Tabassum Tariq, 2016. "Capital Buffers and Bank Risk: Empirical Study of Adjustment of Pakistani Banks," International Journal of Economics and Financial Issues, Econjournals, vol. 6(4), pages 1798-1806.
    8. Marc Saidenberg & Til Schuermann & May, "undated". "The New Basel Capital Accord and Questions for Research," Center for Financial Institutions Working Papers 03-14, Wharton School Center for Financial Institutions, University of Pennsylvania.
    9. Krainer, Robert, 2009. "Portfolio and financing adjustments for U.S. banks: Some empirical evidence," Journal of Financial Stability, Elsevier, vol. 5(1), pages 1-24, January.
    10. Andrea Orame, 2020. "The role of bank supply in the Italian credit market: evidence from a new regional survey," Temi di discussione (Economic working papers) 1279, Bank of Italy, Economic Research and International Relations Area.
    11. Mendicino, Caterina & Nikolov, Kalin & Ramirez, Juan-Rubio & Suarez, Javier & Supera, Dominik, 2020. "Twin defaults and bank capital requirements," Working Paper Series 2414, European Central Bank.
    12. Krainer, Robert E., 2013. "Towards a program for financial stability," Journal of Economic Behavior & Organization, Elsevier, vol. 85(C), pages 207-218.
    13. Gabriel Jiménez & Jesús Saurina, 2006. "Credit Cycles, Credit Risk, and Prudential Regulation," International Journal of Central Banking, International Journal of Central Banking, vol. 2(2), May.
    14. Ebrahimi Kahou, Mahdi & Lehar, Alfred, 2017. "Macroprudential policy: A review," Journal of Financial Stability, Elsevier, vol. 29(C), pages 92-105.
    15. Nijskens, Rob & Mokas, Dimitris, 2019. "Credit Risk in Commercial Real Estate Bank Loans : The Role of Idiosyncratic versus Macro-Economic Factors," Other publications TiSEM ea4f2f0e-dc50-4987-91d3-6, Tilburg University, School of Economics and Management.
    16. André Lucas & Siem Jan Koopman, 2005. "Business and default cycles for credit risk," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(2), pages 311-323.
    17. Wahyoe Soedarmono & Amine Tarazi & Agusman Agusman & Gary S. Monroe & Dominic Gasbarro, 2016. "Loan Loss Provisions and Lending Behavior of Banks: Do Information Sharing and Borrower Legal Rights Matter?," Working Papers hal-01316717, HAL.
    18. Derviz, Alexis, 2014. "Collateral composition, diversification risk, and systemically important merchant banks," Journal of Financial Stability, Elsevier, vol. 14(C), pages 23-34.
    19. Krainer, Robert E., 2014. "Monetary policy and bank lending in the Euro area: Is there a stock market channel or an interest rate channel?," Journal of International Money and Finance, Elsevier, vol. 49(PB), pages 283-298.
    20. Rafael Repullo & Javier Suarez, 2013. "The Procyclical Effects of Bank Capital Regulation," The Review of Financial Studies, Society for Financial Studies, vol. 26(2), pages 452-490.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:fmktpm:v:19:y:2005:i:2:p:179-200. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.