TROUBLESHOOTING BASEL II: THE ISSUE OF PROCYCLICALITY

A widespread concern about Basel II capital requirements is that it might amplify business cycle fluctuations, forcing banks to restrict their lending when the economy goes into recession. Under the IRB approach of Basel II, capital requirements are increasing functions of the probability of default (PD), loss given default (LGD) and exposure at default (EAD) parameters estimated for each borrower, and these inputs are likely to rise in economic downturns. In this paper, we compare two alternative procedures that are designed to somehow moderate the procyclical effects induced by Basel II - type capital regulation. The starting points of our analysis consist Jokivuolla, Kiema and Vesala (2009) and Repullo and Suarez (2009), who both examined the impact of regulatory capital's procyclical effects. It's vital to note remarks of Caprio (2009), that is, making regulatory capital levels countercyclical could worsen the state of an economy during a recession. As we do not have access to the Romanian Central Credit Register database, we compute a model-economy that stands as a proxy for the Romanian firms' sector. Our simulated Romanian economy can be characterised by all Romania-specific macroeconomic controls. Then we estimate a model of PDs during the period 2000 - 2010, and based on the estimated probabilities of default we compute the corresponding series of Basel II capital requirements. After the diagnosis of procyclicality, we analyze two procedures that try to mitigate the cyclical effects of capital regulation: smoothing the output of the Basel II formula, and smoothing the input, by construction of through-the-cycle (TTC) PDs. The comparison of the different procedures is based on the criterion of minimizing the root mean square deviations of each adjusted series. Our results show that the best ways to moderate procyclicality are either to smooth the input of the Basel II formula by using through-the-cycle PDs, or to smooth the output with a multiplier based on GDP growth. We conclude that the GDP-based smoothing may be more efficient than the use of TTC PDs in terms of simplicity and transparency. In terms of the GDP adjustment, regulatory capital levels should increase with approx. 1,31% during an economic growth period and decrease with 4,03% during a recession, in order to mitigate the cyclical effects induced by Basel II - type capital regulation.Basel II, procyclicality, regulatory capital, probability of default, credit-crunch

Safe and sound banking : a role for countercyclical regulatory requirements ?

Most explanations of the crisis of 2007-2009 emphasize the role of the preceding boom in real estate and asset markets in a variety of advanced countries. As a result, an idea that is gaining support among various groups is how to make Basel II or any regulatory regime less pro-cyclical. This paper addresses the rationale for and likely contribution of such policies. Making provisioning (or capital) requirements countercyclical is one way potentially to address pro-cyclicality, and accordingly it looks at the efforts of the authorities in Spain and Colombia, two countries in which countercyclical provisioning has been tried, to see what the track record has been. As explained there, these experiments have been at best too recent and limited to put much weight on them, but they are much less favorable for supporting this practice than is commonly admitted. The paper then addresses concerns and implementation issues with countercyclical capital or provisioning requirements, including why their impact might be expected to be limited, and concludes with recommendations for developing country officials who want to learn how to make their financial systems less exposed to crises.Banks&Banking Reform,Access to Finance,Financial Intermediation,Debt Markets,Emerging Markets

Safe and Sound Banking: A Role for Countercyclical Regulatory Requirements?

Most explanations of the crisis of 2007-2009 emphasize the role of the preceding boom in real estate and asset markets in a variety of advanced countries. As a result, an idea that is gaining support among various groups is how to make Basel II or any regulatory regime less procyclical. This paper addresses the rationale for and likely contribution of such policies. Making provisioning (or capital) requirements countercyclical is one way potentially to address procyclicality, and accordingly it looks at the efforts of the authorities in Spain and Colombia, two countries in which countercyclical provisioning has been tried, to see what the track record has been. As explained there, these experiments have been at best too recent and limited to put much weight on them, but they are much less favorable for supporting this practice than is commonly admitted. The paper then addresses concerns and implementation issues with countercyclical capital or provisioning requirements, including why their impact might be expected to be limited, and concludes with recommendations for developing country officials who want to learn how to make their financial systems less exposed to crises.Financial crisis, Securitization, Regulation and Supervision, Safety Nets

Incentives to Issue Low-Quality Securitized Products in the OTD Business Model

We consider an economy in which a lender finances loans to borrowers by issuing a securitized product to investors and in which the credit quality of the product can depend on whether the lender screens borrowers. In the presence of asymmetric information between the lender and investors regarding the credit quality of potential borrowers, overvaluation from the lender's perspective can occur for low-quality securitized products, which inefficiently induces the lender not to screen borrowers and hence to issue the securitized products of low credit quality. This is likely to occur when the probability of being in a bad state (i.e., the presence of low-quality borrowers) is low, or when the seeds of recession begin emerging in a booming economy.Originate-to-distribute, Securitization, Asymmetric information, Screening, Verification

Macroeconomic determinants of Polish banks’ loan losses – results of a panel data study

The paper investigates the links between business cycle variables and loan losses of Polish commercial banks. A panel approach was chosen in order to make maximum use of available supervisory data, and to capture the impact of bank profile on loan losses. Loan losses are proxied by the flow of loan loss provisions. We find a significant influence of real GDP growth, changes in real interest rate, and labour market variables such as changes in unemployment rate. Due to the high share of FX loans to households, the influence of exchange rate is also examined, but the results are inconclusive. The differences in loan losses between banks can be attributed to differences in business profile, described by classification of banks into “strategic groups”, as well as the structure of loan portfolio. The paper concludes with an example of a stress testing exercise conducted using scenarios generated through the National Bank of Poland’s macroeconomic model.credit risk, banks, Poland, panel data, stress tests

Monetary and Fiscal Policies: Ordinary Recessions and Financial Crises

This paper uses two different samples to study the effects of monetary and fiscal policies on the profiles of recessions and recoveries. Several results emerge from the econometric analysis presented. First, monetary policy during ordinary recessions and banking crises is a powerful tool with lasting effects that extend to recovery growth rates. However, the effect of monetary policy during financial crises is strongly diminished in the case of forbearance – banks left to function despite being technically insolvent. Second, the effectiveness of fiscal policy is reversed – it is a powerful tool during banking crises, but it does not seem to significantly affect recovery growth rates during ordinary recessions. Finally, the policy response during past financial crisis does not seem to be particularly expansionary – on the contrary, fiscal policy is markedly procylcical, while monetary policy is neutral. This is proposed as an alternative explanation to the one usually given for the sluggishness of financial crises

Loan types and the bank lending channel

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中国の中小企業金融 ー 個票データの分析を中心にー

This paper analyzes how the relationship lending affects the condition of the financial constraints and mortgage loans for the SMEs. As a result, as to the validity of the relationship lending, in the case of bank relationships of the SMEs is longer, or the number of banking relationships is smaller, financial constraints can be decreased. Furthermore, this paper shows that, as to real security, terms and conditions can be deregulated in the case of that number of banking relationships is smaller. Also it would be important for SMEs to concentrate their bank relationships on the specific banks and to keep bank relationships tightened. This paper finally shows the relationship lending would be valid for the deregulation of financial constraints and improvement of bank relationships in SMEs loansdepartmental bulletin pape