Implications for banking stability and welfare under capital shocks and countercyclical requirements

Stelios; NILAVONGSE, Rachatar; UDDIN, Gazi Salah Bekiros,
Authors registered in the RePEc Author Service: Gazi Salah Uddin, Rachatar Nilavongse and Stelios Bekiros

No ECO 2017/06, Economics Working Papers from European University Institute

Abstract: This paper incorporates anticipated and unexpected 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, household debt and output fluctuations 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.

Keywords: Banking stability; Basel III; Capital requirements; News shocks; Welfare analysis (search for similar items in EconPapers)
JEL-codes: E32 E44 E52 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-mac
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