Do Capital Buffers Mitigate Volatility of Bank Lending? A Simulation Study

40 Pages Posted: 8 Jun 2016

See all articles by Frank Heid

Frank Heid

Deutsche Bundesbank

Ulrich Krüger

Deutsche Bundesbank

Date Written: 2011

Abstract

Critics claim that capital requirements can exacerbate credit cycles by restricting lending in an economic downturn. The introduction of Basel 2, in particular, has led to concerns that risksensitive capital charges are highly correlated with the business cycle. The Basel Committee is contemplating a revision of the Basel Accord by introducing counter-cyclical capital buffers. Others claim that capital buffers are already large enough to absorb fluctuations in credit risk. We address the question of the pro-cyclical effects of capital requirements in a general framework which takes into account banks' potential adjustment strategies. We develop a dynamic model of bank lending behavior and simulate different regulatory frameworks and macroeconomic scenarios. In particular, we address two related questions in our simulation study: How do business fluctuations affect capital requirements and bank lending? To what extent does the capital buffer absorb fluctuations in the level of mimimum required capital?

Keywords: Minimum capital requirements, regulatory capital, capital buffer, cyclical lending, pro-cyclicality

JEL Classification: C61, E32, E44, G21

Suggested Citation

Heid, Frank and Krüger, Ulrich, Do Capital Buffers Mitigate Volatility of Bank Lending? A Simulation Study (2011). Bundesbank Series 2 Discussion Paper No. 2011,03, Available at SSRN: https://ssrn.com/abstract=2794054 or http://dx.doi.org/10.2139/ssrn.2794054

Frank Heid (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Ulrich Krüger

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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