Business Cycle and Bank Capital Regulation: Basel II Procyclicality
Guangling Liu () and
Nkhahle E. Seeiso
No 221, Working Papers from Economic Research Southern Africa
This paper studies the impacts of bank capital regulation on business cycle fluctuations. To do so, we adopt the Bernanke et al. (1999) "financial accelerator" model (BGG), to which we augment a banking sector to study the procyclical nature of Basel II claimed in the literature. We first study the impacts of a negative shock to entrepreneur's net worth and a positive monetary policy shock on business cycle fluctuations. We then look at the impacts of a negative shock to the entrepreneurs' net worth when the minimum capital requirement increases from 8 percent to 12 percent. Our comparison studies between the augmented BGG model with Basel I bank regulation and the one with Basel II bank regulation suggest that, in the presence of credit market frictions and bank capital regulation, the liquidity premium effect further ampliflies the financial accelerator effect through the external finance premium channel, which in turn, contributes to the amplification of Basel II procyclicality. Moreover, under Basel II bank regulation, in response to a negative net worth shock, the liquidity premium and the external finance premium rise much more if the minimum bank capital requirement increases, which in turn, amplify the response of real variables. Finally, small adjustments in monetary policy can result in stronger response in the real economy, in the presence of Basel II bank regulation in particular, which is undesirable.
Keywords: Business cycle fluctuations; Financial accelerator; Bank capital requirement; Monetary policy (search for similar items in EconPapers)
JEL-codes: E32 E44 G28 E50 (search for similar items in EconPapers)
Pages: 21 pages
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cba, nep-dge, nep-mac and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2) Track citations by RSS feed
Downloads: (external link)
Working Paper: Business Cycle and Bank Capital Regulation: Basel II Procyclicality (2011)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:rza:wpaper:221
Access Statistics for this paper
More papers in Working Papers from Economic Research Southern Africa Contact information at EDIRC.
Bibliographic data for series maintained by Dane Rossenrode ().