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Financial Stability Paper No 3: Monitoring Cyclicality of Basel II Capital Requirements

James Benford and Erlend Nier
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James Benford: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH
Erlend Nier: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH

No 3, Bank of England Financial Stability Papers from Bank of England

Abstract: The use of credit ratings to set capital requirements under Basel II represents an important change to the way banks are regulated. While encouraging better risk management by banks, it also raises the possibility that capital requirements might vary with economic conditions, creating risks to the stability of the financial system. This paper offers some evidence on the likely magnitude of these effects. It then sets out a framework that will be used by the Bank and FSA to monitor Basel II capital requirements. The Bank is particularly interested in possible implications of cyclical variability in capital requirements under Basel II for the UK banking sector in aggregate, while the FSA’s focus is the capital adequacy of individual banks. The paper finally suggests that the industry, as well as market participants, can play a part in avoiding potential unintended consequences of Basel II — through careful capital planning by banks, and scrutiny, by market participants, of the outputs of banks’ rating systems.

Keywords: Cyclicality; Basell II; Bank Regulation (search for similar items in EconPapers)
JEL-codes: G28 (search for similar items in EconPapers)
Pages: 14 pages
Date: 2007-12-21
Note: http://www.bankofengland.co.uk/financialstability/Pages/fpc/fspapers/fs_paper03.aspx
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