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

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Abstract

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.

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Authors and Affiliations

  1. University of Milano-Bicocca and CEFIN, Piazza dell’Ateneo Nuovo 1, 20126, Milan, Italy

    Chiara Pederzoli

  2. University of Modena and Reggio Emilia and CEFIN, Viale Berengario 51, 41100, Modena, Italy

    Costanza Torricelli

  3. St. Edmund Hall and Saïd Business School, University of Oxford, Park End Street, Oxford, OX1 1HP, UK

    Dimitrios P. Tsomocos

Authors
  1. Chiara Pederzoli
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  2. Costanza Torricelli
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  3. Dimitrios P. Tsomocos
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Correspondence to Dimitrios P. Tsomocos.

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Pederzoli, C., Torricelli, C. & Tsomocos, D.P. Rating systems, procyclicality and Basel II: an evaluation in a general equilibrium framework. Ann Finance 6, 33–49 (2010). https://doi.org/10.1007/s10436-009-0128-8

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  • DOI: https://doi.org/10.1007/s10436-009-0128-8

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