FRBNY Assesses Economic Cost of Higher Bank Capital Ratios

The New York Fed has released a staff report by Paolo Angelini, Laurent Clerc, Vasco Cúrdia, Leonardo Gambacorta, Andrea Gerali, Alberto Locarno, Roberto Motto, Werner Roeger, Skander Van den Heuvel, and Jan Vlček titled BASEL III: Long-Term Impact on
Economic Performance and Fluctuations

We assess the long-term economic impact of the new regulatory standards (the Basel III reform), answering the following questions: 1) What is the impact of the reform on long-term economic performance? 2) What is the impact of the reform on economic fluctuations? 3) What is the impact of the adoption of countercyclical capital buffers on economic fluctuations? The main results are the following: 1) Each percentage point increase in the capital ratio causes a median 0.09 percent decline in the level of steady-state output, relative to the baseline. The impact of the new liquidity regulation is of a similar order of magnitude, at 0.08 percent. This paper does not estimate the benefits of the new regulation in terms of reduced frequency and severity of financial crisis, analyzed in Basel Committee on Banking Supervision (2010b). 2) The reform should dampen output volatility; the magnitude of the effect is heterogeneous across models; the median effect is modest. 3) The adoption of countercyclical capital buffers could have a more sizable dampening effect on output volatility. These conclusions are fully consistent with those of reports by the Long-term Economic Impact Group (Basel Committee on Banking Supervision 2010b) and the Macroeconomic Assessment Group (2010b).

The results are also consistent with the Bank of Canada report (discussed in the post BoC Studies Capital Ratio Cost/Benefits, which stated:

The results of this analysis are reported in Table 4, which summarizes the results for both Canada and the LEI study of the long-run impact of tighter capital standards. The range of the results on long-run output loss for the Canadian economy is similar to that observed in the LEI report. The average is similar to the median of the international results—i.e., about 0.1 per cent of GDP for a 1-percentage-point rise in bank capital requirements. Note that a high degree of uncertainty accompanies the calculation of long-run estimates, as evidenced by the wide range of model outcomes. Thus, the focus is on the median results of the Canadian models.

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