The Basel Capital Requirement Ratio and Its Impact
The Basel Capital Requirement Ratio and Its Impact on Banks all over the world July 16 2010, Conference Gala Dinner Computing in Economics and Finance (16 th) Naoyuki YOSHINO Professor of Economics, Keio University, Japan E-mail: yoshino@econ. keio. ac. jp Director, Financial Research & Training Center FSA (Financial Services Agency), Government of Japan Tomohiro HIRANO Research Fellow, Financial Research & Training Center FSA (Financial Services Agency), Government of Japan 1
Bank Loan/GDP Ratio (Bubble) USA JAPAN 2
Various Proposals for Minimum Capital Requirement exist 1, Adjustable minimum capital requirement ratio --->raise in good times and reduce in bad times 2, Boom country higher capital requirement Sluggish country Lower requirement 3, Adjustment Factors to the Basel Capital Requirement 4, Ryozo Himino (2009) Ex. Stock Price Index 3
The Basel minimum capital requirement should be different from country to country since the economic structures are different from each other. A simple general equilibrium model suggests that the optimal minimum capital requirement ratio depends on the structure of the economy (i. e. Asset Price, GDP, Interest rate) 4
Bank’s Balance Sheet Assets Liabilities Bank Loans Good Assets Deposits Non Performing Loans (NPL) Capital=A(q) Bad Assets 5
A Simple General Equilibrium Model 1, Objective of the Basel Minimum Capital Requirement Stabilize bank lending (L) Minimize (L-L*)2 [Capital/Risk Weighted Assets]> Minimum Basel Capital Requirement (θ) 2, Banks: Maximize their profits 3, Macroeconomic variables (i) land price (q 1), (ii) Stock price (q 2), (iii) GDP (Y), (iv) interest rate (i. B) 6
Derivation of the Optimal Value for θ (θ =minimum capital requirement) Minimize Loss = (L-L*)2 sub to Bank’s Profits sub to Balance Sheet of Bank sub to A(q)/K(ρe)>θ The optimal minimum capital requirement is expressed as follows: θt* = f (L*, q 1, q 2, Y, i. B) 7
Min(Lt-L*)² Bank Profits 兀＝i. L（L）x L ＋i. B×B－ρe(q, Y, i. B, qe)×L － im(θ－θ*)×D－C（ L, B, D） Balance Sheet Constraint L+B＝D+A(ｑ) Capital Ratio = Capital / Risk Weighted Assets A(q) --------------- ≧θ K[ρe(q, Y, i. B, qe)]×L ≧θ 8
Banks are maximizing their profits πe : Expected profit of Bank. ) where im(θ－θ*) il : interest rate on risky asset L: Risky assets (bank loans etc. ) i. B: interest rate on safe assets B: safe assets (such as government bond) ρe: ratio of the expected default loan losses D: deposits and funds absorbed from the short term market im: the rate of interest charged to deposits or short term borrowing from the market C(L, B, q 1, q 2): various costs, q 1=land price, q 2=stock price 9
i’L(L)×L＋iＬ(L)－ρe－C’L+λ 1＝０・・・ （１） Demand for Bank Loans L=ｄ０－ｄ１ i. L+d 2 Y+d 3 q 1+d 4 q 2・・・・・ ・（２） Loan Market Equilibrium L＝d 0/2＋d 2/2・Y＋d 3/2・q －1/2(ρe－C’L－im－ C’D)…. . (3) Min(Lt-L*)² sub. to (3) Total differentiation yields : dθ = α 1 dq 1＋α 2 dq 2＋α 3 d. Y＋α 4 di. B 10
A Simple Macroeconomic Model ・Land Price （3） ・Stock Price （4） ・Bond Market （5） ・Goods Market （6） 11
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How much % would the Based Minimum Capital Requirement be adjusted in Japan? based on Japanese Data 1996 Q 1 -2008 Q 4 land price (q 1), stock price (q 2), GDP(Y), interest rate (IB) 13
1 2 2 3 Changes in Land price (dq 1) K (default risk) Changes in Stock price (dq 2) K, A(bank’s cap. ) Changes in business condition (d. Y) K Changed in interest rate (di. B) K (default risk) Risk Asset ratio (K) changes Bank’s Capital (A(q 1))changes 14
=-2. 20% 1998 Q 1 -2008 Q 4 15
Empirical Results of Optimal Minimum Capital Requirement (1) Japan Estimation 1996 Q 1 – 2008 Q 4 θ = -2. 20 % (=5. 80%) 1998 Q 1 -2008 Q 4 (2) USA Estimation 1995 Q 1 – 2008 Q 4 θ = + 4. 42 % (=12. 42%) 2002 Q 4 – 2007 Q 4 θ = - 1. 116 %(=7. 884%) 2001 Q 1 – 2002 Q 4 (3) Canada θ＝ ＋0. 37% (=8. 37%) 2003 Q 1 – 2004 Q 4 16 θ＝＋0. 96%（＝ 8. 96%) 2006 Q 1 – 2007 Q 4
Conclusion 1 1 Adjustable minimum capital requirement ratio -->raise in good times and reduce in bad times 2, Boom country higher capital requirement Sluggish country Lower requirement 3, Adjustment Factors to the Basel Capital Requirement (i)Land Price (ii) Stock Price (iii) GDP (iv) Interest rate 17
1 Two country model (Cross-Border) 1 2 Country A Country B Capital Requirement A% Capital Requirement B% Bank should follow Each country’s minimum capital requirement ratio (A% or B%) 18
2, Two country model (Cross-Border) 1 3 Country A Boom Capital Requirement A% Domestic Loans (1) Cross-border Loans (3) Capital Requirement A% 2 Country B Recession Capital Requirement B% Domestic Loans (2) Cap. Req. B% 19
Conclusion 2 Cross-border Case 1 Boom country – higher minimum capital (A) contracted country – lower minimum capital (B) 2 Different minimum capital requirement A% & B%. lending and asset management in each country should follow each minimum capital requirement 3 Regulator has to be able to monitor each country sources of absorbed assets Asset management 20
Mitsubishi-Tokyo-UFJ Bank Mitsubishi. Tokyo. UFJ 120000000 10000 80000000 60000000 Mitsubishi. Tokyo. UFJ 40000000 20000000 0 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 21
Japanese Banks’ Behavior 22
Marginal Revenue = Marginal Cost 23
Profits of Japanese Banks 24
Estimates of Bank Loans, Japan 25
References Naoyuki Yoshino, Tomohiro Hirano, and Kakeru Miura, (2009), “The Optimal Basel Capital Requirement to Cope with Procyclicality: A Theoretical Approach”, (Financial Research and Training Center, Financial Services Agency (FSA), Government of Japan. FRTS Discussion papers, DP 2009 -6) http: //www. fsa. go. jp/frtc/english/seika/discussion. html Himino, Ryozo. , (2009), “A counter-cyclical Basel II, ” RISK magazine, 01, Mar 2009 Revankar N. and Yoshino, N. , (2008) “An Empirical Analysis of Japanese Banking Behavior in a Period of Financial Instability, ” Keio Economic Studies, Vol. 45 No. 1. Yoshino, Naoyuki and Tetsuro Mizoguchi (2010) “The Role of Public Works in the Political Business Cycle and the Instability of 26 the Budget Deficits in Japan” (Asian Economic Papers, MIT Press).
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