The Global Macroeconomic Costs of Raising Bank Capital Adequacy Requirements

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1 W/1/44 The Global Macroeconomc Costs of Rasng Bank Captal Adequacy Requrements Scott Roger and Francs Vtek

2 01 Internatonal Monetary Fund W/1/44 IMF Workng aper IMF Offces n Europe Monetary and Captal Markets Department Strategy olcy and Revew Department The Global Macroeconomc Costs of Rasng Bank Captal Adequacy Requrements repared by Scott Roger and Francs Vtek Authorzed for dstrbuton by Emmanuel van der Mensbrugghe and Martn Mulhesen February 01 Ths Workng aper should not be reported as representng the vews of the IMF. The vews expressed n ths Workng aper are those of the author(s) and do not necessarly represent those of the IMF or IMF polcy. Workng apers descrbe research n progress by the author(s) and are publshed to elct comments and to further debate. Abstract Ths paper examnes the transtonal macroeconomc costs of a synchronzed global ncrease n bank captal adequacy requrements under Basel III as well as a captal ncrease coverng globally systemcally mportant banks. The analyss usng an estmated mult-country model contrbuted to the work of the Macroeconomc Assessment Group analyss especally n estmatng the potental nternatonal spllovers assocated wth a global ncrease n captal requrements. The magntude of the effects found n ths analyss s relatvely modest especally f monetary polces have scope to ease n response to a wdenng of nterest rate spreads by banks. JEL Classfcaton Numbers: E44 F41 G1 G8 Keywords: Captal requrements Basel III Authors E-Mal Addresses:

3 Contents age I. Introducton... 3 II. The MAG Approach and the Role of the Mult-country Analyss... 4 III. The Mult-country Macroeconometrc Model... 5 IV. Smulatons and Results... 6 V. Concludng Comments and Caveats References Appendces A. The Macroeconometrc Model... 0 B. Estmaton... 6 C. Descrpton of the Data Set D. Impulse Responses... 3 Tables 1. Estmated Impact of a 1 age ont Increase n Captal Requrements on Average Bank Lendng Spreads eak Impact on GD from a Global Increase n Captal Requrements wth no Monetary olcy Responses eak Impact on GD from a Global Increase n Captal Requrements wth Monetary olcy Responses eak Impact on GD from an Increase n 30 GSIB Captal Requrements wth no Monetary olcy Responses eak Impact on GD from an Increase n 30 GSIB Captal Requrements wth Monetary olcy Responses arameter Estmaton Results... 9 Fgures 1. Effects of a Global Increase n Captal Requrements over 8 Years for all Banks wth no Change n olcy Interest Rates Effects of Economy-Specfc Increases n Captal Requrements for all Banks over 8 Years wth no Change n olcy Interest Rates Effects of a Global Increase n Captal Requrements for all Banks over 8 Years wth Endogenous Monetary olcy Responses Effects of Economy-Specfc Increases n Captal Requrements for all Banks over 8 Years wth Endogenous Monetary olcy Responses... 35

4 3 I. INTRODUCTION 1. Ths paper analyzes the transtonal macroeconomc costs of strengthenng bank captal adequacy requrements ncludng a general ncrease n captal requrements as well as an ncrease specfcally for globally systemcally mportant banks (GSIBS). In addton to estmatng the mpact of ntroducng hgher captal requrements n each of 15 major economes the analyss also ncludes estmates of the nternatonal spllover effects assocated wth the smultaneous ntroducton of hgher captal requrements by all 15 countres. The smulatons are generated wthn the framework of an extended and refned verson of the mult-country macroeconometrc model of the world economy developed and estmated by Vtek (009).. Ths analyss contrbuted to the work of the Macroeconomc Assessment Group (MAG) chared by the Bank for Internatonal Settlements (BIS) and the Long-term Economc Impact (LEI) group of the Basel Commttee for Bankng Stablty (BCBS). 1 The MAG partcpants ncludng the IMF used a varety of models to estmate the medum-term macroeconomc costs of strengthenng captal and lqudty requrements. The analyss presented n ths paper reflectng the MAG mandate focuses solely on the short-term to medum-term output costs of the proposed new regulatory measures. Estmates of the net benefts of these regulatory measures can be found n the LEI report (BCBS 010). 3. The macroeconomc effects of an ncrease n captal adequacy requrements are assumed n ths analyss to be transmtted exclusvely va ncreases n the spread between commercal bank lendng rates and the central bank polcy rate. We estmate that n the absence of any monetary polcy response a permanent synchronzed global ncrease n captal requrements for all banks by 1 percentage pont would cause a peak reducton n GD of around percentage ponts of whch around percentage ponts would result from nternatonal spllovers. Losses n emergng market economes are found to be somewhat hgher than n advanced economes. If monetary polcy s able to respond however the adverse mpact of hgher captal requrements could be largely offset 4. Wth regard to strengthenng captal requrements specfcally for GSIBs we estmate that a 1 percentage pont ncrease n captal requrements for the top 30 GSIBs would cause a 1 See MAG (010a b) BCBS (010) and MAG (011). One of the DSGE models used n the exercse s descrbed n Roger and Vlcek (011).

5 4 medan peak reducton n GD of around 7 percentage ponts of whch 4 percentage ponts or 5 percent results from nternatonal spllovers. The aggregate fgures conceal a wde range of outcomes however and for some countres nternatonal spllovers would be the man source of macroeconomc effects. 5. It s mportant to bear n mnd the lmtatons of the model and assumptons used n the analyss. In partcular the analyss does not take account of other possble responses by banks or other fnancal nsttutons to changes n captal requrements or non-lneartes n the response of fnancal systems monetary polcy or the real economy. Nor does the model allow for changes n the macroeconomc steady state assocated wth very persstent wdenng of lendng spreads. Addtonally the analyss does not take account of the dfferent ntal startng ponts of dfferent countres n rasng captal requrements or dfferences n the speed of mplementaton. II. THE MAG AROACH AND THE ROLE OF THE MULTI-COUNTRY ANALYSIS 6. As dscussed n the MAG Interm and Fnal reports (MAG 010a b) the MAG employed a varety of modelng strateges to estmate the transtonal macroeconomc costs of ntroducng hgher bank captal requrements. The most common approach nvolved a two step procedure. In the frst step countres estmated the mpact on nterest rate spreads of rasng Ter 1 captal requrements on banks by 1 percentage pont over several dfferent mplementaton horzons. In the second step countres then used standard macroeconomc models to estmate the mpact on growth of a wdenng of credt spreads. 3 In most cases the macroeconomc smulatons consdered two alternatve polcy scenaros: one n whch monetary polcy dd not respond to the macroeconomc effects of the change n captal requrements; whle under the alternatve scenaro monetary polcy was allowed to react n a normal fashon. 7. In the follow-up MAG analyss (MAG 011) of the effects of rasng captal requrements for globally systemcally mportant banks (G-SIBs) essentally the same approach was used but wth ncreases n captal requrements and ther effects pro-rated 3 Ths approach partly reflected the lmtatons of most exstng manstream macroeconomc models n analyzng fnancal or prudental ssues but also reflected a vew that over a relatvely lengthy mplementaton perod banks were most lkely to buld up captal through some wdenng of spreads rather than through cuttng lendng. A number of models used n the MAG exercse however were able to consder the mpact of tghter credt standards as a means of rasng captal asset ratos. See e.g. Roger and Vlcek (011).

6 5 accordng to the mportance of G-SIBs n natonal fnancal systems. Alternatve scenaros agan allowed for dfferences n mplementaton perods and monetary polcy responses. In addton alternatve scenaros were constructed for dfferent possble numbers of G-SIBs. 8. The mult-country model reported n ths paper contrbuted mportantly to the MAG analyses by provdng estmates on a country by country bass of the nternatonal macroeconomc spllovers assocated wth the ncreases n captal requrements both for a generalzed ncrease n requrements and for G-SIBs specfcally. In the natonal macroeconomc analyses the models allowed for an ncrease n captal requrements domestcally but dd not make allowance for the smultaneous ncrease n captal requrements n other countres. Wth the mult-country model however t was possble to estmate the macroeconomc effects of ndvdual countres rasng captal requrements as well as the effects of all countres rasng captal requrements together. The nternatonal macroeconomc spllover for each country could then be calculated by subtractng the effects of each country rasng captal requrements alone from the effects when all countres rased captal requrements together. As wth the natonal analyses the mult-country model exercse consdered alternatve horzons for mplementng hgher captal requrements as well as alternatve monetary polcy scenaros and dfferent numbers of G-SIBs subject to addtonal requrements. 9. The mult-country model estmates of the macroeconomc effects of ncreased nterest rate spreads were also used as complements to the natonal model estmates. Instead of relyng on sngle models to estmate these effects the MAG approach nvolved aggregatng results across models to obtan more robust estmates as well as a sense of a plausble range of outcomes. III. THE MULTI-COUNTRY MACROECONOMETRIC MODEL 10. The macroeconometrc model used n ths analyss s a panel unobserved components model of 15 major advanced and emergng market economes. Ths structural macroeconometrc model features extensve lnkages between the real and fnancal sectors both wthn and across economes. Wthn each economy cyclcal components are modeled as a multvarate lnear ratonal expectatons model of the monetary transmsson mechansm whle trend components are modeled as ndependent random walks. The tradtonal nterest rate and exchange rate channels of monetary transmsson are amplfed and propagated by a

7 6 fnancal accelerator mechansm lnked to the real value of an nternatonally dversfed equty portfolo. For a detaled descrpton of ths model please refer to Appendx A. 11. The mult-country model s estmated wth a Bayesan procedure condtonal on pror nformaton concernng the values of parameters and judgment concernng the paths of trend components. For a detaled descrpton of ths estmaton procedure please refer to Appendx B. The data set conssts of observatons on the levels of a total of 18 macroeconomc and fnancal market varables observed for 15 economes over the perod 1999Q1 through 011Q1. The economes modeled are Australa Brazl Canada Chna France Germany Italy Japan Korea Mexco the Netherlands Span Swtzerland the Unted Kngdom and the Unted States. 4 The macroeconomc varables under consderaton are the prce of output the prce of consumpton the quantty of output the quantty of domestc demand and the prces of energy and non-energy commodtes. The fnancal market varables under consderaton are the nomnal polcy nterest rate the short term nomnal market nterest rate the long term nomnal market nterest rate the prce of equty and the nomnal blateral exchange rate versus the US dollar. For a detaled descrpton of ths data set please refer to Appendx C. IV. SIMULATIONS AND RESULTS 1. The mult-country model analyss of the mpact of ncreases n global and G-SIB captal requrements as wth most of the models employed n ths exercse assumes that the prmary response of banks to an ncrease n captal requrements wll be a wdenng of lendng spreads (relatve to what they would otherwse have been). The wdenng of spreads would generate larger proft margns whch would then be used to buld up bank captal. The analyss therefore does not take nto account other possble responses such as new equty ssuance ncreases n proft margns through effcency gans or through asset dsposals or lendng cutbacks. The potental mpact of these alternatve bank responses s dscussed n more detal n the MAG reports. 4 For the analyss ncluded n the 010 MAG report a slghtly dfferent sample perod and groupng of countres was used. In the earler analyss the sample perod covered 1991Q1-010Q. The country groupng dffered from the current groupng by omttng the Netherlands and Swtzerland and ncluded Inda and Russa. As a consequence the results reported n ths paper for a global ncrease n captal requrements dffer somewhat from those reported n the MAG 010 reports but the dfferences are not substantal.

8 7 13. The startng pont for the analyss are country-by-country estmates of the mpact of hgher captal requrements on domestc retal nterest rate spreads. In the case of an ncrease n global captal requrements MAG partcpants used natonal models to estmate the mpact of a 1 percentage pont ncrease n captal requrements for all banks on bank lendng spreads over the central bank polcy rate. In the case of an ncrease n captal requrements applyng to G- SIBs the nterest rate effect was scaled by the share of G-SIB lendng n total domestc bank lendng (see MAG 011). The results of the natonal model estmates are reported n Table 1 both for a generalzed ncrease n captal requrements and for ncreases for dfferent numbers of G-SIBs. Usng these spreads the macroeconomc effects on each country were calculated n varous scenaros as descrbed below. Table 1: Estmated Impact of a 1 age ont Increase n Captal Requrements on Average Bank Lendng Spreads (n bass ponts) GD Weght All Banks Global Systemcally Important Banks Twenty Thrty Forty Australa Brazl Canada Chna France Germany Italy Japan Korea Mexco Netherlands Span Swtzerland Unted Kngdom Unted States World Advanced Economes Emergng Economes Source: MAG (010b 011) A. A Global Increase n Captal Requrements 14. The frst MAG exercse focused on the short- to medum-term macroeconomc costs of a generalzed ncrease n captal requrements under Basel III. As noted above the prmary

9 8 channel of transmsson was assumed to be through ncreases n bank lendng spreads. 5 In the ntal analyss (MAG 010a) most estmates of macroeconomc effects were based on a 100 bass pont (b.p.) ncrease n lendng spreads whle n the fnal analyss (MAG 010b) estmates were based on a 1 percentage pont ncrease n captal adequacy requrements. 15. An mportant shortcomng of the analyses usng natonal macroeconomc models s that they do not take nto account the smultaneous mplementaton of hgher captal requrements on a mult-country bass. If a sngle country rases ts captal requrements whle the rest of the world does not then the contractonary mpact on GD n that country wll be cushoned by the sustaned strength of foregn demand. That mplctly s what natonal level analyses do. If all countres rase captal requrements smultaneously however external demand no longer provdes a cushon for GD. As a consequence natonal estmates wll typcally understate the adverse mpact on GD of a generalzed ncrease n captal requrements. 16. The key contrbuton of the mult-country model to the MAG exercses has been to take nto account the smultanety of the ncreases n captal requrements. Ths s done by comparng two basc scenaros. In the frst baselne scenaro all countres are assumed to rase captal requrements by the same amount (1 percentage pont) over the same perod (4 to 8 years). In the alternatve scenaro each country s assumed to ncrease ts captal requrements whle others do not equvalent to the natonal modelng exercses. The dfference between these two scenaros amounts to the nternatonal spllover effect of the smultaneous change n regulatory requrements. 17. Based on ths approach the model was smulated for a standardzed 1 percentage pont ncrease n global captal requrements resultng n ncreases n nterest rate spreads as shown under the all banks column n Table 1. Wthn ths general scenaro however two mportant varatons n assumptons were consdered. The frst was to vary the speed of mplementaton of the ncrease n captal requrements usng 4 6 and 8 year mplementaton horzons. In each case the ncrease n captal requrements was assumed to be mplemented n a lnear fashon. 18. The second man varaton n assumptons concerns the response of monetary polcy to the macro-prudental measures. In normal crcumstances central banks n the varous countres would adjust polcy nterest rates to counter the macroeconomc effects of the ncrease n 5 As dscussed n MAG (010a b) many dfferent models were employed n the analyss. Although most models only allowed for transmsson va a wdenng of nterest rate spreads a good number of others allowed for nonprce effects through credt ratonng.

10 9 captal requrements. 6 However gven the very low level of polcy nterest rates n many countres the scope for monetary polcy easng could be constraned by a zero lower bound on nomnal nterest rates at least over part of the mplementaton horzon. To allow for ths possblty the mplementaton of the ncrease was smulated n one set of scenaros wth a normal polcy response smlar to a Taylor Rule whle n the second scenaro the nomnal nterest rate was held constant The macroeconomc transmsson of the change n captal requrements s as follows. To meet hgher captal requrements banks rase lendng spreads over the central bank polcy rate. In the absence of a monetary polcy response the real market nterest rate rses and real equty wealth falls nducng a contracton n domestc demand through ntertemporal substtuton and wealth effects. In the case of a sngle country rasng ts captal requrements the rse n market nterest rates also leads to apprecaton of the currency n real effectve terms amplfyng the contracton n output as real net exports declne and as the real nterest rate s further boosted temporarly by lower mported goods prces. If monetary polcy s able to respond however a lowerng of the polcy rate can largely offset the mpact of the wdenng of spreads. 0. In the case of a synchronzed global ncrease n captal requrements the contractonary effects of ncreases n domestc nterest rates are amplfed by nternatonal trade and fnancal lnkages. Contractons n foregn demand wll dampen exports to those countres whle declnes n foregn equty values wll adversely affect the value of nternatonally dversfed portfolos wth adverse wealth effects on consumpton. In addton movements of exchange rates n response to changes n nternatonal nterest rate dfferentals may amplfy or moderate the demand and prce effects of the shock. Weaker global demand also dampens nflaton through downward pressures on commodty prces. As wth a sngle country ncrease n captal requrements the effects of a global ncrease n captal requrements can be substantally offset f countres are able to respond to the rse n captal requrements wth an easng of the stance of monetary polcy. 1. An mportant challenge n the modelng exercse faced by all partcpants ncludng ourselves was how to deal wth the very long duraton of the shock to nterest rate spreads 6 For Euro Area (EA) countres nterest rates are assumed to respond dentcally to EA (GD-weghted) averages for nflaton and output n the EA countres n the model (Germany France Italy Span and the Netherlands). 7 The constant nterest rate assumpton was mposed by offsettng devatons from monetary polcy rules wth monetary polcy shocks.

11 10 partcularly n the scenaros wth no monetary polcy response. Although n prncple the wdenng of spreads would be partly or even largely transtory 8 they would nonetheless be qute persstent especally n the scenaros wth lengthy phasng n of the requrements. Such persstent shocks are dffcult to deal wth n gap models whch take the steady state as gven. In the event of very persstent or permanent shocks however the steady state equlbrum s lkely to be affected. The BCBS (010) estmated that a 1 percentage pont ncrease n captal requrements would lead to a 9 percentage pont reducton n the level of potental output. To address the ssue of changng potental output n the MAG exercse a restrcted Kalman flter was appled the output paths generated by the model n ths paper so that over the long term the level of potental would converge towards the model forecast for actual output. The results reported n ths paper however focus on the actual levels of output snce ths s a better ndcator of the magntude of the mpact on output than s the estmated output gap.. Impulse responses of major varables n the 15 MAG economes n response to countryspecfc and global ncreases n captal requrements are shown n Appendx D. Tables and 3 provde a summary vew of the peak mpact on output n the dfferent countres mplemented over a range of dfferent perods both when monetary polcy s able to respond and when nterest rates are held constant. Key features of the results shown n the tables nclude: In the absence of any monetary polcy response a synchronzed global ncrease n captal requrements by 1 percentage pont s estmated to have a peak mpact on output of close to percentage ponts (Table ). Of ths about percentage ponts reflect the nternatonal spllover effects of the smultaneous global ntroducton of hgher captal requrements. There s substantal varaton n the magntude of output effects across countres wth the lowest estmated mpact n the Unted States ( percentage ponts) and the hghest n Chna ( percentage ponts). Dfferences partly reflect the pattern of nterest rate ncreases assocated wth hgher captal requrements. Countres experencng hgher nterest rate ncreases (as shown n Table 1) tend to have the largest adverse mpact on output as shown n the alternatve scenaros based on country-specfc captal rato ncreases. But varatons n spllovers also play a role wth more open economes wth less flexble exchange rates tendng to experence relatvely large spllovers. 8 Once target ncreases n captal were acheved banks would then reduce spreads n order to stablze captal ratos at the requred level. A small part of the ncrease n captal ratos however would lkely be permanent. See BCBS (010).

12 11 Shortenng the mplementaton perod would accentuate the peak mpact on growth and the output gap but the permanent mpact on output would be essentally unaffected. The scope for monetary polcy to mtgate output losses s potentally large. Assumng that monetary polcy s able to take the ncrease n spreads nto account over the 4 to 8 year mplementaton horzon the mpact of hgher captal requrements on output could be substantally offset. In partcular the smulatons suggest that the peak mpact on output would be reduced to a lttle over percentage ponts (Table 3). In a few cases the nternatonal spllovers may slghtly boost growth. Ths arses n a few cases n the Euro Area where monetary polcy s targeted at area-wde nflaton and output. In such crcumstances the common monetary polcy stance may be a bt too stmulatve for some members (France Italy and Span) and nsuffcently so for other members (Germany and the Netherlands). 3. These estmates of the macroeconomc costs from rasng captal requrements for all banks are broadly consstent wth those reported n the exstng emprcal lterature after accountng for dfferences n underlyng assumptons. Abstractng from monetary polcy accommodaton our estmated peak output losses from economy-specfc captal requrement ncreases le near the top of the dstrbuton of comparable smulaton results reported n MAG (010a b). Ths may result from our restrcton on the nomnal polcy nterest rate beng tghter than n other analyses n the sense that t also apples after the mplementaton perod. Fnally our estmated contrbutons from spllovers to these peak output losses are consstent wth those reported n Resende Db and erevalov (010).

13 1 Table : eak Impact on GD from a Global Increase n Captal Requrements wth no Monetary olcy Responses 1/ Weght Four Years Sx Years Eght Years Baselne Alternatve Spllovers Baselne Alternatve Spllovers Baselne Alternatve Spllovers Australa Brazl Canada Chna France Germany Italy Japan Korea Mexco Netherlands Span Swtzerland Unted Kngdom Unted States Unweghted medan Unweghted mean GD weghted medan GD weghted mean Advanced Economes Emergng Economes Source: Authors 1/ Reports smulated peak output losses (measured n percent) n response to a 1 percentage pont ncrease n regulatory captal adequacy requrements for all banks phased n at a constant speed over the stated mplementaton perod. The scenaros assume unchanged polcy nterest rates. The baselne scenaro features a global synchronzed ncrease n captal requrements whle the alternatve scenaros feature economy specfc ncreases synchronzed wthn the Euro Area. GD weghts are based on 005 GD. Table 3: eak Impact on GD from a Global Increase n Captal Requrements wth Monetary olcy Responses 1/ Weght Four Years Sx Years Eght Years Baselne Alternatve Spllovers Baselne Alternatve Spllovers Baselne Alternatve Spllovers Australa Brazl Canada Chna France Germany Italy Japan Korea Mexco Netherlands Span Swtzerland Unted Kngdom Unted States Unweghted medan Unweghted mean GD weghted medan GD weghted mean Advanced Economes Emergng Economes Source: Authors 1/ Reports smulated peak output losses (measured n percent) n response to a 1 percentage pont ncrease n regulatory captal adequacy requrements for all banks phased n at a constant speed over the stated mplementaton perod. The scenaros assume endogenous monetary polcy responses. The baselne scenaro features a global synchronzed ncrease n captal requrements whle the alternatve scenaros feature economy specfc ncreases synchronzed wthn the Euro Area. GD weghts are based on 005 GD.

14 13 B. An Increase n Captal Requrements for Globally Systemcally Important Banks 4. In the 011 MAG exercse an ncrease n captal requrements appled to Globally Systemcally Important Banks (GSIBs) was assessed usng the same methodology as for the global ncrease n captal requrements for all banks as descrbed earler. Smulatons were conducted for 4 6 and 8 year mplementaton horzons; wth and wthout monetary polcy responses; and for country-specfc as well as smultaneous global ncreases n captal requrements for GSIBs. 5. In the GSIB analyss however estmates of the ncrease n spreads n each country reflected the share of GSIBs n total lendng n that country. That s the estmated mpact on spreads of an ncrease n captal requrements for all banks was scaled by the GSIB share of lendng n each country. 9 Because the number of banks that would be classfed as GSIBs was not known at the tme the analyss was undertaken the MAG examned alternatves based on 0 30 and 40 GSIBs. The estmated mpact on spreads s shown n Table 1. The mpact on spreads vares consderably from country to country partly reflectng large dfferences n the mportance of GSIBs n lendng n dfferent countres. In Mexco for example even though there are no Mexcan GSIBs foregn GSIBs play a large role n lendng so that the ncrease n spreads s much larger than average. In contrast GSIBs have very small lendng shares n Australa and Korea so that spreads are lttle affected by the ncrease n captal requrements. 6. The analyss of the macroeconomc mpact of the ncrease n captal requrements for GSIBs reflects the large varatons n the mportance of GSIBs n the varous natonal bankng systems as well as the mportance of takng nternatonal spllovers nto account. The estmated mpact on output of hgher GSIB captal requrements for the case of 30 GSIBs (whch s closest to the group eventually selected) are shown n Tables 4 and 5 below. 9 See BCBS (011).

15 14 Table 4: eak Impact on GD from an Increase n 30 GSIB Captal Requrements wth no Monetary olcy Responses 1/ Weght Four Years Sx Years Eght Years Baselne Alternatve Spllovers Baselne Alternatve Spllovers Baselne Alternatve Spllovers Australa Brazl Canada Chna France Germany Italy Japan Korea Mexco Netherlands Span Swtzerland Unted Kngdom Unted States Unweghted medan Unweghted mean GD weghted medan GD weghted mean Advanced Economes Emergng Economes / Reports smulated peak output losses (measured n percent) n response to a 1 percentage pont ncrease n regulatory captal adequacy requrements for the 30 most mportant GSIBs phased n at a constant speed over the stated mplementaton perod. The scenaros assume unchanged polcy nterest rates. The baselne scenaro features a global synchronzed ncrease n GSIB captal requrements whle the alternatve scenaros feature economy specfc ncreases synchronzed wthn the Euro Area. GD weghts are based on 005 GD. Table 5: eak Impact on GD from an Increase n 30 GSIB Captal Requrements wth Monetary olcy Responses 1/ Weght Four Years Sx Years Eght Years Baselne Alternatve Spllovers Baselne Alternatve Spllovers Baselne Alternatve Spllovers Australa Brazl Canada Chna France Germany Italy Japan Korea Mexco Netherlands Span Swtzerland Unted Kngdom Unted States Unweghted medan Unweghted mean GD weghted medan GD weghted mean Advanced Economes Emergng Economes / Reports smulated peak output losses (measured n percent) n response to a 1 percentage pont ncrease n regulatory captal adequacy requrements for the 30 most mportant GSIBs phased n at a constant speed over the stated mplementaton perod. The scenaros assume endogenous monetary polcy responses. The baselne scenaro features a global synchronzed ncrease n GSIB captal requrements whle the alternatve scenaros feature economy specfc ncreases synchronzed wthn the Euro Area. GD weghts are based on 005 GD.

16 15 7. Notable features of the results nclude: In the absence of any monetary polcy response to a 1 percentage pont rse n GSIB captal requrements the medan peak adverse mpact on GD s estmated at 7 percentage ponts of whch an average of close to one quarter or 4 percentage ponts would stem from nternatonal spllovers assocated wth the smultaneous mplementaton of hgher captal requrements. In the analyss based on 0 GSIBs the medan peak output loss was estmated at percentage ponts whle n the case of 40 GSIBs the loss was estmated at 0 percentage ponts. There s a wde dsperson of outcomes wth Australa estmated to experence a peak output loss of just 8 percentage ponts whle Japan s loss s estmated at 6 percentage ponts. For several countres nternatonal spllover effects are partcularly mportant. For these countres ncludng Australa Canada Chna and Korea although GSIBs have relatvely small drect mportance for ther bankng sectors ther economes are sgnfcantly exposed to countres such as Japan and the Unted States where GSIBs are relatvely mportant. As a consequence for these countres spllovers are estmated to account for more than half of the total mpact on ther GD. As n the case of a global ncrease n captal requrements f monetary polces are able to respond to an ncrease n GSIB captal requrements the output effects can be substantally reduced. V. CONCLUDING COMMENTS AND CAVEATS 8. The mult-country macroeconomc model used n ths analyss contrbuted mportantly to the MAG assessments of the potental mpact over the medum term of a global ncrease n captal requrements both for all banks and for a smaller group of GSIBs. The results of the mult-country analyss ndcate that nternatonal spllovers assocated wth coordnated polcy measures are mportant our analyss suggests that spllovers typcally account for 0-5 percent of the total mpact on output. Moreover n the case of an ncrease n captal requrements for GSIBs nternatonal spllovers may be the prmary source of macroeconomc effects.

17 16 9. At the same tme t s mportant to recognze the mportant lmtatons assocated both wth the model and wth the exercse t was used n. Wth regard to the model the man lmtatons to emphasze are that: As dscussed earler the model s not geared to dealng wth changes n the steady state assocated wth permanent or very persstent shocks. Although the quanttatve sgnfcance of ths does not appear to be large n the context of ths exercse t suggests that the estmated effects of a permanent ncrease n nterest rate spreads should be nterpreted wth cauton partcularly at long horzons. The model has only one avenue for the ncrease n captal requrements to affect the real economy; though a wdenng of bank lendng spreads over the polcy rate. As dscussed n the MAG reports there are several ways n whch banks can respond to hgher captal requrements and some could have much more sgnfcant effects on output whle others would be more bengn. 30. The exercses themselves have some mportant lmtatons that should be borne n mnd n assessng the quanttatve results and rsks surroundng them. These nclude: The mplementaton of the hgher captal requrements s assumed to be lnear over the alternatve mplementaton perods. In practce the speed of mplementaton s qute lkely to be non-lnear; ndeed markets may be forcng a front-loadng of adjustment. The scope for monetary polcy responses may well vary over tme and dffer from one country to another. Not all countres are close to the zero lower bound for nterest rates and even those that are may not reman so over the entre mplementaton perod. Consequently macroeconomc outcomes and spllovers are bound to dffer from those suggested by the model analyss. The analyss should be thought of as showng bounds for potental outcomes assocated wth dfferent monetary polces. The analyses only consder standardzed ncreases n captal requrements by 1 percentage pont. However the effects of ncreases n requrements may well be nonlnear so that ncreasng requrements by percentage ponts may be not be smply twce as much as a 1 percentage pont ncrease and the degree of non-lnearty may not be the same across tme or countres. The zero lower bound constrant s one such nonlnearty but there are lkely to be others.

18 17 The analyss of the global ncrease n captal requrements assumed an dentcal ncrease n captal requrements n all countres. In realty banks n some countres wll have much further to go n meetng hgher captal requrements than banks n other countres. As a consequence the pace of ncreases n nterest rate spreads wll vary across countres. As seen n the exercse wth GSIBs where spreads ncreased by dfferent amounts n dfferent countres ths would sgnfcantly modfy the pattern of macroeconomc effects and ther spllovers between countres.

19 18 REFERENCES Basel Commttee on Bankng Supervson (BCBS) 010 An Assessment of the Long-term Economc Impact of Stronger Captal and Lqudty Requrements Bank for Internatonal Settlements August. Engle R. and M. Watson 1981 A One-factor Multvarate Tme Seres Model of Metropoltan Wage Rates Journal of the Amercan Statstcal Assocaton Hodrck R. and E. rescott 1997 ost-war U.S. Busness Cycles: A Descrptve Emprcal Investgaton Journal of Money Credt and Bankng Kalman R A New Approach to Lnear Flterng and redcton roblems Transactons ASME Journal of Basc Engneerng Klen. 000 Usng the Generalzed Schur Form to Solve a Multvarate Lnear Ratonal Expectatons Model Journal of Economc Dynamcs and Control Macroeconomc Assessment Group (MAG) 010a Assessng the Macroeconomc Impact of the Transton to Stronger Captal and Lqudty Requrements Interm Report Bank for Internatonal Settlements August. Macroeconomc Assessment Group (MAG) 010b Assessng the Macroeconomc Impact of the Transton to Stronger Captal and Lqudty Requrements Fnal Report Bank for Internatonal Settlements December. Macroeconomc Assessment Group (MAG) 011 Assessment of the Macroeconomc Impact of Hgher Loss Absorbancy for Global Systemcally Important Banks Report Bank for Internatonal Settlements October. Resende C. A. Db and N. erevalov 010 The Macroeconomc Implcatons of Changes n Bank Captal and Lqudty Requrements n Canada: Insghts from the BoC-GEM- FIN Bank of Canada Dscusson aper 16. Roger S. and J. Vlcek 011 Macroeconomc Costs of Hgher Bank Captal and Lqudty Requrements Internatonal Monetary Fund Workng aper 11/103.

20 19 Vtek F. 009 Monetary olcy Analyss and Forecastng n the World Economy: A anel Unobserved Components Approach Internatonal Monetary Fund Workng aper 09/38.

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