Annals of Finance

, 6:33 | Cite as

Rating systems, procyclicality and Basel II: an evaluation in a general equilibrium framework

  • Chiara Pederzoli
  • Costanza Torricelli
  • Dimitrios P. Tsomocos
Research Article


The introduction of Basel II has raised concerns about the potential impact of risk-sensitive capital requirements on the business cycle. Several approaches have been proposed to assess the procyclicality issue. In this paper, we adopt a general equilibrium model and conduct comprehensive analysis of different proposals. We set out a model that allows to evaluate different rating systems in relation to the procyclicality issue. Our model extends previous models by analysing the effects of different rating systems on banks’ portfolios (as in Catarineu et al. in Econ Theory 26:537–557, 2005) and the contagion effects relevant to financial stability (as in Goodhart et al. in Ann Finance 1:197–224, 2005). The paper presents comparative statics results comparing a cycle-dependent and a neutral rating system from the point of view of banks profit maximization. Our results suggest that banks’ preferences about point in time or through the cycle rating systems depend on the banks’ characteristics and on the business cycle conditions in terms of expectations and realizations.


Procyclicality Rating systems Basel II General equilibrium 

JEL Classification

D58 E44 G21 G38 


  1. Bangia A., Diebold F., Kronimus A., Schagen C., Schuermann T.: Ratings migration and the business cycle, with application to credit portfolio stress testing. J Banking Financ 26, 445–474 (2002)CrossRefGoogle Scholar
  2. Basel Committee on Banking Supervision (BCBS): International convergence of capital measurement and capital standards—a revised framework. June 2006 (2006)Google Scholar
  3. Borio, C., Furfine, C., Lowe, P.: Procyclicality of the financial system and Financial stability: issues and policy options. BIS Paper, 1 (2001)Google Scholar
  4. Catarineu-Rabell E., Jackson P., Tsomocos D.: Procyclicality and the new Basel accord: banks’choice of loan rating system. Econ Theory 26, 537–557 (2005)CrossRefGoogle Scholar
  5. Daniellson, J., Embrechts, P., Goodhart, C., Keating, C., Muennich, F., Renault, O., Shin, H.S.: A academic response to Basel II. London School of Economics, Financial Markets Group, Special Paper 130 (2001)Google Scholar
  6. Goodhart C.A.E., Sunirand P., Tsomocos D.: A model to analyse financial fragility: applications. J Financial Stab 1, 1–30 (2004)Google Scholar
  7. Goodhart C.A.E., Sunirand P., Tsomocos D.: A risk assessment model for banks. Ann Finance 1, 197–224 (2005)CrossRefGoogle Scholar
  8. Goodhart C.A.E., Sunirand P., Tsomocos D.: A model to analyse financial fragility. Econ Theory 27, 107–142 (2006)CrossRefGoogle Scholar
  9. Gordy M., Howells B.: Procyclicality in Basel II: can we treat the disease without killing the patient? J Financial Intermed 15, 395–417 (2006)CrossRefGoogle Scholar
  10. Herranz, N., Krasa, S., Villamil, A.: The impact of owners and policy on small firms. Working Paper, University of Illinois (2008)Google Scholar
  11. Jokivuolle, E., Vesala, T.: Portfolio effects and efficiency of lending under Basel II. Bank of Finland Research, Discussion Papers 13 (2007)Google Scholar
  12. Kashyap, A., Stein, J.: Cyclical implications of the Basel II Capital Standards. Federal Reserve Bank of Chicago Economic Perspective, 1st Quarter, 18–31 (2004)Google Scholar
  13. Masschelein, N.: Monitoring pro-cyclicality under the capital requirement directive: preliminary concepts for developing a framework. Natiolal Bank of Belgium, Working Paper Document 120 (2007)Google Scholar
  14. Nickell P., Perraudin W., Varotto S.: Stability of rating transitions. J Banking Financ 24, 203–227 (2000)CrossRefGoogle Scholar
  15. Pederzoli C., Torricelli C.: Capital requirements and business cycle regimes: forward-looking modelling of default probabilities. J Banking Financ 29, 3121–3140 (2005)CrossRefGoogle Scholar
  16. Repullo, R., Suarez, J.: The procyclical effects of Basel II. CEPR Discussion Paper, 6862 (2008)Google Scholar
  17. Tsomocos D.: Equilibrium analysis, banking and financial instability. J Math Econ 39, 619–655 (2003)CrossRefGoogle Scholar

Copyright information

© Springer-Verlag 2009

Authors and Affiliations

  • Chiara Pederzoli
    • 1
  • Costanza Torricelli
    • 2
  • Dimitrios P. Tsomocos
    • 3
  1. 1.University of Milano-Bicocca and CEFINMilanItaly
  2. 2.University of Modena and Reggio Emilia and CEFINModenaItaly
  3. 3.St. Edmund Hall and Saïd Business School, University of OxfordOxfordUK

Personalised recommendations