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Financial Stability Paper No 3: Monitoring Cyclicality of Basel II Capital Requirements

Author

Listed:
  • Benford, James

    (Bank of England)

  • Nier, Erlend

    (Bank of England)

Abstract
The use of credit ratings to set capital requirements under Basel II represents an important change to the way banks are regulated. While encouraging better risk management by banks, it also raises the possibility that capital requirements might vary with economic conditions, creating risks to the stability of the financial system. This paper offers some evidence on the likely magnitude of these effects. It then sets out a framework that will be used by the Bank and FSA to monitor Basel II capital requirements. The Bank is particularly interested in possible implications of cyclical variability in capital requirements under Basel II for the UK banking sector in aggregate, while the FSA’s focus is the capital adequacy of individual banks. The paper finally suggests that the industry, as well as market participants, can play a part in avoiding potential unintended consequences of Basel II — through careful capital planning by banks, and scrutiny, by market participants, of the outputs of banks’ rating systems.

Suggested Citation

  • Benford, James & Nier, Erlend, 2007. "Financial Stability Paper No 3: Monitoring Cyclicality of Basel II Capital Requirements," Bank of England Financial Stability Papers 3, Bank of England.
    • Handle: RePEc:boe:finsta:0003
    Note: http://www.bankofengland.co.uk/financialstability/Pages/fpc/fspapers/fs_paper03.aspx
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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-paper/2007/monitoring-cyclicality-of-basel-ii-capital-requirements
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    References listed on IDEAS

    as
    1. Eva Catarineu-Rabell & Patricia Jackson & Dimitrios Tsomocos, 2005. "Procyclicality and the new Basel Accord - banks’ choice of loan rating system," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 26(3), pages 537-557, October.
    2. Haldane, Andrew & Hall, Simon & Pezzini, Silvia, 2007. "Financial Stability Paper No 2: A New Approach to Assessing Risks to Financial Stability," Bank of England Financial Stability Papers 2, Bank of England.
    3. 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.
    4. 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.
    5. Nier, Erlend & Baumann, Ursel, 2006. "Market discipline, disclosure and moral hazard in banking," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 332-361, July.
    6. Philip Lowe & Miguel Angel Segoviano, 2002. "Internal ratings, the business cycle, and capital requirements: some evidence from an emerging market economy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston.
    7. Philip Lowe & Miguel A. Segoviano, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," BIS Working Papers 117, Bank for International Settlements.
    8. Segoviano, Miguel A. & Lowe, Philip, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," LSE Research Online Documents on Economics 24948, London School of Economics and Political Science, LSE Library.
    9. Mark S. Carey & William F. Treacy, 1998. "Credit risk rating at large U.S. banks," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), vol. 84(Nov), pages 897-921, September.
    10. C. H. Furfine & Jeffery D. Amato, 2003. "Are credit ratings procyclical?," BIS Working Papers 129, Bank for International Settlements.
    11. Philip Lowe, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," FMG Discussion Papers dp428, Financial Markets Group.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Andersen, Henrik, 2011. "Procyclical implications of Basel II: Can the cyclicality of capital requirements be contained?," Journal of Financial Stability, Elsevier, vol. 7(3), pages 138-154, August.
    2. Cécile Bastidon, 2013. "Un modèle théorique d'intermédiation : transmission et gestion des chocs," Post-Print hal-00806524, HAL.
    3. Uluc, Arzu & Wieladek, Tomasz, 2015. "Capital requirements, risk shifting and the mortgage market," Bank of England working papers 572, Bank of England.
    4. Antão, Paula & Lacerda, Ana, 2011. "Capital requirements under the credit risk-based framework," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1380-1390, June.
    5. De Marco, Filippo & Kneer, Christiane & Wieladek, Tomasz, 2021. "The real effects of capital requirements and monetary policy: Evidence from the United Kingdom," Journal of Banking & Finance, Elsevier, vol. 133(C).
    6. Agénor, P.-R. & Alper, K. & Pereira da Silva, L., 2012. "Capital requirements and business cycles with credit market imperfections," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 687-705.
    7. Henrik Andersen, 2009. "Norwegian banks in a recession: Procyclical implications of Basel II," Working Paper 2009/04, Norges Bank.
    8. S Ingolfsson & B T Elvarsson, 2010. "Cyclical adjustment of point-in-time PD," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 61(3), pages 374-380, March.
    9. Joshua Coval & Jakub Jurek & Erik Stafford, 2009. "The Economics of Structured Finance," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 3-25, Winter.
    10. Jørn Inge Halvorsen & Dag Henning Jacobsen, 2009. "Are bank lending shocks important for economic fluctuations?," Working Paper 2009/27, Norges Bank.
    11. Cécile Bastidon, 2014. "Households credits and financial stability," Post-Print hal-01021280, HAL.
    12. repec:cnb:ocpubc:fsr0910/3 is not listed on IDEAS
    13. Uluc, Arzu & Wieladek, Tomasz, 2018. "Capital requirements, monetary policy and risk shifting in the mortgage market," Journal of Financial Intermediation, Elsevier, vol. 35(PB), pages 3-16.

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    More about this item

    Keywords

    Cyclicality; Basell II; Bank Regulation;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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