A Computable General Equilibrium Model as a Banking Sector Regulatory Tool in South Africa

Abstract

A Computable General Equilibrium (CGE) model is used as a regulatory tool for the banking sector in South Africa. The model is used to determine the effects of regulatory penalties, capital adequacy requirements (CAR), and the monetary policy on the economy. Our results indicate that there is a trade off between the default and the CAR regulation. For example, reducing the default penalty the banks profits increase whereas reducing the CAR violation penalty banks profits decrease. The effects of changing the default penalty are stronger than the ones of changing the CAR violation penalty such that when both penalties are reduced the banks profits increase. Moreover, regulatory policies which are targeted at different banks produce asymmetric results as well capitalized banks with richer portfolios swiftly readjust their balance sheet and transfer the default externality to the more constrained banks and/or the private sector agents. Finally, during periods of adverse economic conditions, tightening regulatory requirements reduces the banks profitability and increases defaults, and hence increases financial fragility.

Keywords: Computable General Equilibrium; Banking Regulation; Capital Requirement; Base Money; Policy Rate

JEL Classification: D58, E52, G28