Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy

Philip Lowe and Miguel Segoviano
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Philip Lowe: Reserve Bank of Australia
Miguel Segoviano: International Monetary Fund (IMF) - Monetary, Financial Systems Department

No 117, BIS Working Papers from Bank for International Settlements

Abstract: The concept of risk-based capital requirements enjoys widespread support. Effective implementation, however, requires that risk be measured accurately both across borrowers and across time. Under the New Capital Accord, the cornerstone of this risk measurement process is the rating of the borrower. In this paper we use the ratings assigned by individual Mexican banks to examine how measured credit risk for these banks has changed since the financial crisis in the mid-1990s. We then examine the implications of these changes in risk for regulatory capital under the proposed changes to the Basel Capital Accord. We find that measured risk increased after the crisis and then fell as the recovery took hold. In turn, despite the limitations of the data, we find that the proposed internal ratings-based approach would have generated large swings in regulatory capital requirements over the second half of the 1990s, with required capital increasing significantly in the aftermath of the crisis, and then falling as the economy recovered. Looking forward, if movements in actual bank capital were to show this same cyclical variation, then business cycle fluctuations might be amplified by developments in the banking industry.

Keywords: risk-based capital requirements; New Capital Accord; rating of the borrower (search for similar items in EconPapers)
Pages: 27 pages
Date: 2002-09
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Citations: View citations in EconPapers (70)

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