Skip to main content

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


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.

This is a preview of subscription content, access via your institution.


  • 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)

    Article  Google Scholar 

  • Basel Committee on Banking Supervision (BCBS): International convergence of capital measurement and capital standards—a revised framework. June 2006 (2006)

  • Borio, C., Furfine, C., Lowe, P.: Procyclicality of the financial system and Financial stability: issues and policy options. BIS Paper, 1 (2001)

  • 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)

    Article  Google Scholar 

  • 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)

  • Goodhart C.A.E., Sunirand P., Tsomocos D.: A model to analyse financial fragility: applications. J Financial Stab 1, 1–30 (2004)

    Google Scholar 

  • Goodhart C.A.E., Sunirand P., Tsomocos D.: A risk assessment model for banks. Ann Finance 1, 197–224 (2005)

    Article  Google Scholar 

  • Goodhart C.A.E., Sunirand P., Tsomocos D.: A model to analyse financial fragility. Econ Theory 27, 107–142 (2006)

    Article  Google Scholar 

  • Gordy M., Howells B.: Procyclicality in Basel II: can we treat the disease without killing the patient? J Financial Intermed 15, 395–417 (2006)

    Article  Google Scholar 

  • Herranz, N., Krasa, S., Villamil, A.: The impact of owners and policy on small firms. Working Paper, University of Illinois (2008)

  • Jokivuolle, E., Vesala, T.: Portfolio effects and efficiency of lending under Basel II. Bank of Finland Research, Discussion Papers 13 (2007)

  • Kashyap, A., Stein, J.: Cyclical implications of the Basel II Capital Standards. Federal Reserve Bank of Chicago Economic Perspective, 1st Quarter, 18–31 (2004)

  • 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)

  • Nickell P., Perraudin W., Varotto S.: Stability of rating transitions. J Banking Financ 24, 203–227 (2000)

    Article  Google Scholar 

  • Pederzoli C., Torricelli C.: Capital requirements and business cycle regimes: forward-looking modelling of default probabilities. J Banking Financ 29, 3121–3140 (2005)

    Article  Google Scholar 

  • Repullo, R., Suarez, J.: The procyclical effects of Basel II. CEPR Discussion Paper, 6862 (2008)

  • Tsomocos D.: Equilibrium analysis, banking and financial instability. J Math Econ 39, 619–655 (2003)

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations


Corresponding author

Correspondence to Dimitrios P. Tsomocos.

Rights and permissions

Reprints and Permissions

About this article

Cite this article

Pederzoli, C., Torricelli, C. & Tsomocos, D.P. Rating systems, procyclicality and Basel II: an evaluation in a general equilibrium framework. Ann Finance 6, 33 (2010).

Download citation

  • Received:

  • Accepted:

  • Published:

  • DOI:


  • Procyclicality
  • Rating systems
  • Basel II
  • General equilibrium

JEL Classification

  • D58
  • E44
  • G21
  • G38