BCBS published a working paper that assesses the costs and benefits of stronger capital and liquidity requirements. The paper finds that the net macroeconomic benefits of capital requirements are positive over a wide range of capital levels. The paper also suggests a set of issues that warrant further monitoring and research. These issues include the link between capital and the cost and probability of crises, accounting for the effects of liquidity regulations, resolution regimes and countercyclical capital buffers, and the impact of regulation on loan quantities.
The range of estimates for the theoretically optimal level of capital requirements—where marginal benefits equal marginal costs—is likely either similar or higher than was originally estimated by the Basel Committee. This conclusion is, however, subject to a number of important considerations:
- First, estimates of optimal capital are sensitive to a number of assumptions and design choices. For example, the literature differs in judgments made about the permanence of crisis effects as well as assumptions about the efficacy of post crisis reforms, such as liquidity regulations and bank resolution regimes, in reducing the probability and costs of future banking crisis. In some cases, these judgments can offset the upward tendency in the range of optimal capital.
- Second, differences in (net) benefit estimates can reflect different conditioning assumptions such as starting levels of capital or default thresholds (the capital ratio at which firms are assumed to fail) when estimating the impact of capital in reducing crisis probabilities.
- Finally, the estimates are based on capital ratios that are measured in different units. For example, some studies provide optimal capital estimates in risk-weighted ratios, others in leverage ratios. Additionally, across the risk-weighted ratio estimates, the definition of capital and risk-weighted assets (RWAs) can also differ (for example, tangible common equity or tier 1 or common equity tier 1 capital; Basel II RWAs vs. Basel III measures of RWAs).
Keywords: International, Banking, Regulatory Capital, Liquidity Requirements, Liquidity Risk, CET 1, Basel III, BCBS
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