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Housing and credit market shocks: Exploring the role of rule-based Basel III counter-cyclical capital requirements

Guangling Liu and Thabang Molise

Economic Modelling, 2019, vol. 82, issue C, 264-279

Abstract: This paper examines the extent to which the Basel III bank capital regulation attenuates fluctuations in housing and credit markets and fosters financial and macroeconomic stability. We use a positive housing demand shock to mimic a housing market boom and a negative financial shock for credit squeeze and economic meltdown. The results show that the rule-based Basel III counter-cyclical capital requirement effectively attenuates fluctuations in housing and credit markets and prevents bubbles. In the case of a negative financial shock, it significantly reduces the magnitude of economic meltdown. Our analysis of the transition from Basel II to Basel III suggests that it is the counter-cyclical capital buffer that effectively mitigates the pro-cyclicality of its predecessor, while the impact of the conservative buffer is marginal. In contrast to the credit-to-GDP ratio, the optimal policy analysis suggests that the regulatory authority should adjust the capital requirement to changes in credit and output when implementing the counter-cyclical buffer. Future research could extend the study by comparing the effectiveness of the rule-based Basel III with other macroprudential tools in achieving financial and macroeconomic stability.

Keywords: Basel III; Counter-cyclical capital requirements; DSGE; Financial stability; Macroprudential policy (search for similar items in EconPapers)
JEL-codes: E44 E47 E58 G28 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1016/j.econmod.2019.01.013

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