The Dark Side of the Implementation of Basel Capital Requirements: Theory, Evidence and Policy
43 Pages Posted: 28 Jul 2017 Last revised: 18 Oct 2017
Date Written: July 24, 2017
Following the recommendations of the Basel Committee, most financial systems around the world have imposed new capital requirements for banks in the past years. This policy seems to be justified on two powerful economic grounds. First, better capitalized banks promote financial stability by reducing banks’ incentives to take risks and increasing banks’ buffers against losses. Second, lack of compliance with a set of rules established by an internationally recognized institution such as the Basel Committee may harm confidence on a country’s financial system. This paper argues that the implementation of Basel capital requirements may be socially undesirable, at least in some countries. First, as shown in many empirical studies, higher capital requirements may reduce people’s access to finance by either increasing the cost of debt or reducing the volume of loans. Moreover, while this contraction of credit may be harmful for any economy, it will generate a greater impact in emerging markets, taking into account their less developed capital markets and their greater problems of financial exclusion. Therefore, the implementation of new capital requirements will be even more harmful in these countries. Second, the one-size-fits-all model incentivized by the Basel Committee does not take into account a country’s specific features. Indeed, even though the stability of the financial system is a primary goal in all jurisdictions, legal and accounting rules may vary across jurisdictions, and each financial system may have different problems and infrastructures. For this reason, the Basel Committee may recommend policies that, in some circumstances, may not be needed in some jurisdictions, or it may not address a problem that could be a relevant weakness in particular financial system. In our opinion, the presence and power of certain countries in the Basel Committee makes Basel recommendations partially biased toward those problems existing in these jurisdictions. Based on the aforementioned problems, this paper suggests some policy recommendations to promote a more resilient financial system without hampering financial inclusion and economic growth.
Keywords: capital requirements, Basel Accords, Basel III, Basel Committee, financial regulation, access to finance, tax benefits of debt, financial inclusion, economic growth.
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