Measuring the impact of prudential policy on the macroeconomy: A practical application to Basel III and other responses to the financial crisis

de-Ramon, Sebastián and Iscenko, Zanna and Osborne, Matthew and Straughan, Michael and Andrews, Peter (2012): Measuring the impact of prudential policy on the macroeconomy: A practical application to Basel III and other responses to the financial crisis. Published in: FSA Occasional Paper series No. 42 (May 2012)

Abstract

When financial regulators require banks to hold a higher ratio of equity capital to debt funding, banks incur short-term costs as they adjust their balance sheets and lose some of the advantages associated with their existing funding mix. They then seek to maintain post-tax income by, for example, raising lending margins. Higher lending margins tend to lower the volumes of borrowing. This creates a trade-off between the greater stability associated with a higher ratio of equity capital to debt funding and the level of economic activity in the short to medium term. While the benefits of greater stability are obviously very large, and the reduction in economic activity is very unlikely to be on a comparable scale, exploring the trade-off is not straightforward. Past work on this did not solve all of the modelling problems, nor does this paper. We do, however, report some useful developments, which may assist in calibrating policy or monitoring the impacts of judgements already made.

• Item Type: MPRA Paper
• Language: English
• Keywords: banking; capital requirements; impact assessment; macroeconomic impact
• Subjects: D - Microeconomics > D2 - Production and Organizations > D22 - Firm Behavior: Empirical Analysis; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets; E - Macroeconomics and Monetary Economics > E0 - General > E02 - Institutions and the Macroeconomy; G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation

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