Economic Costs and Benefits of BIS Proposals to Increase Capital Requirements for Large Global Banks

Date Published 10/11/2011
Author Marja Hoek-Smit

The Financial Stability Board (FSB) and Basel Committee on Banking Supervision (BCBS) released an assessment of the macroeconomic costs and benefits of proposals for higher loss absorbency for global systemically important banks (G-SIBs) -- Assessing the macroeconomic impact of higher loss absorbency for global systemically important banks.
In July 2011, the Basel committee proposed stronger requirements for loss absorbency by G-SIBs in a consultative document. The current assessment, which was prepared by the joint FSB-BCBS Macroeconomic Assessment Group (MAG) in close collaboration with the International Monetary Fund, analysis the economic benefits and costs of the proposed reforms to increase capital and liquidity requirements for G-SIBs.

The conclusions as summarized in the Executive Summary are as follows:

“The costs of the G-SIB proposals stem from the adverse impact on economic activity, especially investment, of banks' actions to increase interest rate spreads and cut lending in order to build up their capital buffers. The MAG estimated the impact of higher capital requirements on G-SIBs by scaling the impact of raising capital requirements on the banking system as a whole, reported by the MAG in 2010, by the share of G-SIBs in domestic financial systems. While these shares vary across jurisdictions, the share of the top 30 potential G-SIBs (using the Basel Committee's proposed methodology and end-2009 data) averages about 30% of domestic lending and 38% of financial system assets in the MAG economies.

If we use lending shares as a scaling factor, raising capital requirements on the top 30 potential G-SIBs by 1 percentage point over eight years leads to only a modest slowdown in growth. GDP falls to a level 0.06% below its baseline forecast, followed by a recovery. This represents an additional drag on growth of less than 0.01 percentage points per year during the phase-in period. The primary driver of this macroeconomic impact is an increase of lending spreads of 5-6 basis points. Soon after implementation is complete, growth is forecast to be somewhat faster than trend until GDP returns to its baseline. The aggregate figures conceal significant differences across countries, which reflect differences in the role of G-SIBs in the domestic financial system and in current levels of bank capital buffers. International spillovers are also important, and in some countries are likely to be the dominant source of macroeconomic effects.

The overall results are robust to variations in key assumptions. Using a longer list of banks, scaling by assets rather than lending, shortening the implementation period, or limiting the ability of authorities to offset slower growth with monetary or macroprudential policy were all found to increase the growth impact, but not markedly.

What will be the effect of the full package of the Basel Committee's proposals for stronger capital requirements - the set of buffers that will be required of all banks under Basel III, combined with the additional buffers to be carried by G-SIBs? The impact of the Basel III proposals, using the end-2009 global capital levels as a starting point, was calculated by the MAG in 2010. On top of this, we assume for illustrative purposes that the top 30 G-SIBs will need to raise their capital ratios by an additional 2 percentage points,1 and that both parts of the reform are implemented over eight years. Adding together these two components, we find that the impact is again quite small, with GDP at the point of peak impact forecast to have fallen 0.34% relative to its baseline level. Roughly 0.04 percentage points are subtracted from annual growth during this period, while lending spreads rise by around 31 basis points. As before, different assumptions lead to different effects, with faster implementation or a weaker monetary policy response increasing the impact on GDP.

The benefits of the G-SIB framework relate primarily to the reduction in the exposure of the financial system to systemic crises that can have long-lasting effects on the economy. The LEI estimated the benefits of Basel III by multiplying the degree to which it reduces the annual probability of a systemic crisis, by an estimate of the overall cost of a typical crisis in terms of lost output. Drawing on the LEI's results, the MAG estimated that raising capital ratios on G-SIBs could produce an annual benefit in the order of 0.5% of GDP, while the Basel III and G-SIB proposals combined contribute an annual benefit of up to 2.5% of GDP - many times the costs of the reforms in terms of temporarily slower annual growth.”

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