Monitoring Cyclicality of Basel II Capital Requirements

14 Pages Posted: 14 Aug 2009

See all articles by James Benford

James Benford

Bank of England

Erlend W. Nier

International Monetary Fund (IMF)

Date Written: December 21, 2007

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.

Suggested Citation

Benford, James and Nier, Erlend W., Monitoring Cyclicality of Basel II Capital Requirements (December 21, 2007). Bank of England Financial Stability Paper No. 3, Available at SSRN: https://ssrn.com/abstract=1447909

James Benford (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Erlend W. Nier

International Monetary Fund (IMF) ( email )

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