Keywords: New Basel Capital Accord, standardized approach, C&I loans, business cycles
Abstract: In the current regulatory framework, capital requirements are based on
risk-weighted assets, but all business loans carry a uniform risk weight,
irrespective of variations in credit risk. The proposed new Capital Accord
of the Bank for International Settlements provides for a greater sensitivity
of capital requirements to credit risk, raising the question of whether,
and to what extent, the new capital standards will intensify business cycles.
In this paper, we evaluate the potential cyclical effects of the "standardized
approach" to risk evaluation in the new Accord, which involves the ratings of
external agencies. We combine Moody's data on changes in U.S. borrowers'
credit ratings since 1970 with estimates of the risk profile of business loans
at commercial banks from the Survey of Terms of Business Lending, and also a
risk profile estimated by Treacy and Carey (1998). We find that the level of
required capital against business loans would be noticeably lower under the new
Accord compared with the current regime. We do not find evidence of any
substantial additional cyclicality in required capital levels under the standardized approach
of the new Accord relative to the current regime.
Full paper (148 KB PDF)
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Last update: November 30, 2001