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The three main pillars of the new regulatory framework for banks are: capital, leverage and liquidity requirements. The assessment of the CRD IV measures shows that there is a sound chance of increasing stability of the banking sector resulting in net benefits for the overall economy. Nevertheless, these findings are surrounded by a high degree of...
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... aspects of current regulation in that field are: risk measurement methodologies, financial reporting, regulatory capital, funding liquidity standards, collateral arrangements, risk concentration limits, compensation schemes, profit distribution restrictions, insurance mechanisms, and more (for an overview of further measures some of which are being analysed by the parallel 'Banking Study', see Annex II). Three of the most discussed ones have been highlighted in the Figure 2: liquidity requirements, leverage ratio requirements and capital requirements. ...
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... key goal of leverage requirements is to ensure the soundness of banks' investment decisions. However, empirical research clearly documents that this link between banks' leverage ratios and the performance of their credit portfolio is weak (see Figure 12). 57 In countries like the US or Canada where the "old-fashioned" leverage ratios have existed alongside the "modern" risk-sensitive requirements, the leverage ratio has helped protect the US banking system from even greater calamity and has been one of the contributing factors behind the robust performance of Canadian banks over the crisis (the Canadian ratio including elements of off-balance sheet assets which the CRD IV also aims to do). ...
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... crucial consequence of securitisation business was that it allowed expanding the total lending by banks thus increasing their returns. This effect can be observed in Figure 20. Very large banks, being involved in the business of securitisation, earned significantly higher returns between 2003 and 2007 Empirical research clearly showed, and the subprime crisis substantiated this fact, that access to and aggressive use of an external loan sales market to manage credit risk leads bigger banks to enjoy lower capital ratios and higher lending as this allows a bank to hold less capital, invest less in low-yield, high-liquidity assets, while at the same time increase its holdings of higher-risk, higher-return assets. ...
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... may induce bank customers to present riskier projects, having the chance of higher returns, but carrying the risk of greater bank instability of the economy as a whole. The overall impact of the capital, leverage and liquidity requirements are indicated in Table 8 and illustrated in Figure 21. ...
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... a long run perspective, with equity and bank interest rates fully adapting to the bank financing risk profile, only the liquidity effect on weighted average cost of capital will prevail, i.e. an increase of 5 basis points per imposed 1% increase of liquidity requirements. Figure 21 shows the constellation of the three variables in 3D. ...
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... all comparable studies, each 1 percentage point reduction in the annual probability of a crisis yields an expected benefit per year equal to 0.6% of output when banking crises are seen to have a permanent effect on real activity. 85 While Annex I provides details on why macroprudential regulation is increasingly becoming important for financial regulation, Figure 22 shows the benefits available by plotting the expected cost of a crisis and the likelihood of a crisis against the potential benefit in the form of a reduction of crisis cost by financial regulation. Our calculations show that without (additional) regulation, the annual expected losses from a crisis would be 8% of GDP. ...
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... Figure 23 and Table 9 it is shown that, in the short run, impacts of capital and liquidity requirements on economic growth are relatively small compared with an average economic recession; the recent financial crisis reduced the economic growth in the European Union by approx. 5% in one year. ...
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... own calculation based on Bankscope data. Figure 24 shows the increase of banking stability depending on the implementation of liquidity standards and capital/leverage requirements. Both regulations add to financial stability. ...
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... one hand, as discussed above the likelihood of banking failures is reduced on the other hand, due to capital and liquidity buffers the effects of financial crisis are dampened. In Figure 25 the break-even plane separates the space of inefficient regulation outcomes, i.e. below the plane, from efficient outcomes, the space above the plane. Figure 25 clearly shows that a combination of capital and liquidity requirements will be most efficient for increasing the stability of the financial system. ...
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... Figure 25 the break-even plane separates the space of inefficient regulation outcomes, i.e. below the plane, from efficient outcomes, the space above the plane. Figure 25 clearly shows that a combination of capital and liquidity requirements will be most efficient for increasing the stability of the financial system. Only capital requirements beyond 13% and above 5% additional liquidity are associated with no extra gains from increased economic stability. ...
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... dimensions of the CRD IV as well as others outlined in the European Commission's public consultation document outlining its envisaged CRD IV measures such as SIFIs and a single rule book are briefly summarised in this section and presented in Figure 26 around the capital ratio equation. ...
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We examine the impact of Federal Reserve stress tests from 2009 to 2016 on U.S. bank liquidity creation. Empirical results show that regulatory stress tests have a negative effect on both on-and off-balance sheet bank liquidity creation and asset-side liquidity creation. As banks enter the stress tests, they reduce their liquidity creation to avoid...
Citations
... Infrastructure projects typically require very long-term financing, something that is not widely on offer presently. Banks face balance sheet and maturity constraints for a number of reasons, including higher funding costs, higher capital requirements, and a continuing need to provision for losses (Reifner, Neuberger, Rissi, & Clerc-Renaud, 2011). Therefore, the potential role of bond markets increases. ...
... Switzerland, Rime (2000) found no significant impact of capital regulations on bank portfolio risk, while Bichsel and Blum (2004) found a positive relationship between changes in capital and asset risk. For cross-sections of 107 countries (Barth et al., 2004) and the EU-27 (Rissi et al., 2011), no robust relationships between bank capital requirements and financial stability measured by non-performing loans or bank fragility could be found. ...
... For a review of the Basel III/CRD IV measures and the related literature seeRissi et al. (2011). ...
... We do not distinguish between tier 1, 2 and 3, as empirical evidence shows that the "quality of equity" is irrelevant from the perspective of fostering financial stability. SeeRissi et al. (2011). ...
The macroprudential regulatory framework of Basel III imposes the same capital and liquidity requirements on all banks around the world to ensure global competitiveness of banks. Using an agent-based model of the financial system, we find that this is not a robust framework to achieve (inter)national financial stability, because efficient regulation has to embrace the economic structure and behaviour of financial market participants, which differ from country to country. Market-based financial systems do not profit from capital and liquidity regulations, but from a ban on proprietary trading (Volcker rule). In homogeneous or bank-based financial systems, the most effective regulatory policy to ensure financial stability depends on the stability measure used. Irrespective of financial system architecture, direct restrictions of banks’ investment portfolios are more effective than indirect restrictions through capital, leverage and liquidity regulations.
We claim that we currently live in a banking regulatory bubble. We review how: i) banking intermediation theory hinges on dealing with borrower-lender asymmetry of information; ii) instead, the presence of complete information is the keystone of the finance theory. Next, we document how finance theory prevailed over banking intermediation theory in shaping banking regulation: This appalling contradiction is the true culprit behind lower credit standards, mounting systemic risk in banking, and macroeconomic debt overhang. Consequently, we discuss actions that, by restoring the consistency of banking regulation with the theory of banking intermediation, would make banking sounder.
[JEL Classification: G01; G14; G21; G28].
Keywords: asymmetric information; relationship lending vs. transactional lending; efficient markets hypothesis; banking regulation inconsistencies; Basel II.
The New Micro-prudential Regulation Framewok of the Banking Sector : Central Aspects, Impacts and Limitations.
This article intends to give a short presentation and assessment of the new rules of banking regulation initiated by Basel III. We first describe the motivations and key breakthroughs of the reform. Then we try to estimate, from a theoretical and empirical point of view, the costs and benefits of this new framework. Lastly we focus on three complementary questions which have to be dealt with to give Basel III its full efficiency.
Classification JEL : E42, F34, G01.
