The Risk-Based Capital Credit Crunch Hypothesis, a Dual Perspective

Abstract

The primary goal sought by the Bank of International Settlements (BIS) and its committee on Banking Supervision (BCBS) is to make banks safer entities and maintain a "level playing field" between them. However, the question of whether this objective can be attained through enforcing capital requirements is still debatable. In fact, there has been a lot of controversy surrounding the impact of regulatory standards, in particular the Basel I and II accords, on crises that occurred soon after the frameworks were introduced to the banking industry. In this research, we explore the hypothesis of whether capital cushions have affected the banks' lending during the 2007-2009 subprime crisis. Using a bank panel dataset obtained from the FDIC covering the period 2004-2009, we observe that capital requirements were indirectly implicated in the crisis while other factors such as leverage, liquidity and securitization played a bigger role by exploiting weaknesses of these requirements. Therefore, these results have direct policy implications with regard to Basel III.

Keywords: Banking, Capital Structure, Financial Crisis

JEL Classification: G2, E5