Skip to main content

Advertisement

Log in

Procyclicality and the new Basel Accord - banks’ choice of loan rating system

  • Research Article
  • Published:
Economic Theory Aims and scope Submit manuscript

Summary.

The Basel Committee on Banking Supervision is proposing to introduce, in 2006, new risk-based requirements for internationally active (and other significant) banks. These will replace the relatively risk-invariant requirements in the current Accord. The new requirements for the largest bank will be based on bank ratings of the probability of default of the borrowers. There is evidence that the choice of loan ratings which are conditional on the point in the economic cycle could lead to sharp increases in capital requirements in recessions. This makes the question of which rating schemes banks will use very important. The paper uses a general equilibrium model of the financial system to explore whether banks would choose to use a countercyclical, procyclical or neutral rating scheme. The results indicate that banks would not choose a stable rating approach, which has important policy implications for the design of the Accord. It makes it important that banks are given incentives to adopt more stable rating schemes. This consideration has been reflected in the Committee’s latest proposals, in October 2002.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Dimitrios P. Tsomocos.

Additional information

Received: 25 October 2003, Revised: 27 April 2004,

JEL Classification Numbers:

D58, E44, G28.

Correspondence to: Dimitrios P. Tsomocos

The authors are grateful to Pamela Nickell for carrying out some of the calculations and Nicola Anderson, Charles Goodhart, Andy Haldane, Glenn Hoggarth, Nobu Kiyotaki, William Klein, Alistair Milne, William Perraudin, Hyun Shin, Paul Tucker, seminar participants at the Bank of England XI European Workshop on General Equilibrium Theory, Federal Reserve Bank of Boston, INSEAD, LSE, the University of Oxford and especially H.M. Polemarchakis for helpful comments and remarks. However, all remaining errors are ours. The views expressed here are those of the authors and do not necessarily reflect those of the Bank of England, and the Bank of Spain.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Catarineu-Rabell, E., Jackson, P. & Tsomocos, D.P. Procyclicality and the new Basel Accord - banks’ choice of loan rating system. Economic Theory 26, 537–557 (2005). https://doi.org/10.1007/s00199-004-0534-0

Download citation

  • Issue Date:

  • DOI: https://doi.org/10.1007/s00199-004-0534-0

Keywords and Phrases:

Navigation