Bank procyclicality, business cycles and capital requirements

The present work seeks to rationalize the procyclical movements of credit, deposits and bank leverage, basic elements that justify the existence of macroprudential policies, and the effects of capital requirements on the business cycle and financial stability. For this purpose, we use an extension of the theoretical framework of Bernanke et al. [Handbook of Macroeconomics, Elsevier, New York, pp 1341–1393, 1999], which includes the presence of banks through the existence of a second asymmetry between banks and depositors. This extension allows us to understand the role of bank capital on the business cycle and, in this way, how credit channels and financial stability are affected by the inclusion of capital requirements as has been proposed in the Basel III Agreement. The results suggest that capital requirements act as a significant financial accelerator in the presence of productivity and monetary shocks. In addition, during expansions, banking capital regulation helps not only the real part of the economy perform better but also the financial part, through lesser leverage for entrepreneurs and banks. Our results also suggest that an asymmetric regulation constraint throughout the business cycle is preferable to a fixed one.