The Basel III regulatory framework, effective as of 1 January 2019, seeks to increase capital requirements for banks in order to improve financial system stability. New research by Swiss Finance Institute Professor Steven Ongena from the University of Zurich and coauthorsProfessor ReintGropp from the Halle Institute for Economic Research and Professor Thomas C. Mosk and Carlo Wix from Goethe University Frankfurt shows that the Basel III reform may be only partially effective and may induce banks to reduce their credit exposure to corporate and retail clients.

Responding to the most recent financial crisis, the Basel Committee on Banking Supervision developed a new regulatory framework, known as Basel III, to increase capital requirements for banks in order to improve financial system stability. With this reform, minimum capital requirements are increased by 50 percent, requiring banks to increase their risk-based capital ratios. Banks can reach this goal by increasing the amount of regulatory capital they hold or by decreasing the quantity of risk-weighted assets they finance.

Swiss Finance Institute Professor Steven Ongena from the University of Zurich and coauthors Professor ReintGropp from the Halle Institute for Economic Research and Professor Thomas C. Mosk and Carlo Wix from Goethe University Frankfurtstudied the impact of the 2011 European Banking Authority capital exercise—which unexpectedly required certain banks to increase their regulatory capital ratios—on banks’ balance sheets and the real economy. Based on this capital exercise, the researchers forecast that the Basel III reform may induce banks to reduce the amount of assets they finance by lowering their credit exposure to corporate and retail clients, but that they will likely not increase their amount of regulatory capital. In this respect, requiring banks to strengthen their regulatory capital instead of the equity ratio might be more effective and thus minimize the negative impact on the real economy.

The full version of the February issue of SFI’s Practitioner Roundups is available athttp://sfi.ch/system/tdf/Roundup_Feb18_English_v2.pdf?file=1.