Impacts of financial regulation on the cyclicality of banks’ capital requirements and on financial stability

Balázs Zsámboki ()
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Balázs Zsámboki: Magyar Nemzeti Bank (central bank of Hungary)

MNB Bulletin (discontinued), 2007, vol. 2, issue 2, 47-53

Abstract: One of the main functions of the central bank is to strengthen the stability of the financial system, an important aspect of which is to take an active part in the legislation process to improve the regulatory environment and to assess the potential impacts of new regulatory measures. In the summer of 2007 substantial changes took place in the governance of financial institutions with the introduction of regulations based on the new Basel capital standards (Basel II). The objective of this study is to investigate the likely consequences of such new bank regulations and their potential impact on financial stability. To this end, the study analyses the foreseeable developments in the cyclicality of capital requirements of banks based on the corporate credit portfolio of internationally active large banks, and points out that bank regulations are not always capable of fulfilling their intended function of enhancing financial stability in times of economic distress. Notably, the prospective increase in the cyclicality of capital requirements could well lead to a deepening of economic problems and to instability in the banking system, if the banking system appears undercapitalised relative to the risks assumed. All of this highlights the need for the development of a forward-looking risk assessment system and a supportive regulatory regime providing proper incentives.

Keywords: Basel II; credit risk; capital requirement; regulation; cyclicality; financial stability. (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 (search for similar items in EconPapers)
Date: 2007
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