The impact of capital regulations: A study of the Basel framework

Abstract: Financial crises are a major issue in modern history. In a great deal of the financial crises there is a banking crisis involved. To regulate and supervise banks the Basel framework was created. With the framework, the aim is to enhance financial stability and to minimize the effect from a potential financial crisis. This paper aims to investigate if banks have changed their behavior, in terms of their lending practices, since the new capital requirements were introduced, and to discuss possible macroeconomic effects. To accomplish this, the analysis is divided into two parts. First, banks' balance sheets in Germany, Italy, Sweden, the United Kingdom and the United States are investigated from January 2003 to January 2019, with a focus on the share of housing loans to total assets and loans to non-financial corporates to total assets. The development of the variables is examined and tested for structural breaks with multiple breakpoint test. Second, the results are analysed with the background from the framework, financial crises and systemic risk to discuss possible macroeconomic effects. The findings of the paper are that it is not possible to find structural changes in the variables, share of housing loans to total assets and loans to non-financial corporates to total assets, directly connected to the implementation of Basel. However, it is possible to observe a trend that banks have changed their behavior during the period. Banks tend to allocate their loans towards loans that require a lower level of capital, such as housing loans. This could imply that banks are more dependent on the housing market to stay stable. From the framework and other studies there is belief that the risk of a banking crisis is lower today, compared with before the framework was implemented. Nevertheless, there are some concerns regarding the regulations. The concern is based on signs that several banks underreport their risk-weighted assets, in order to reduce their required level of capital. In addition to this, there are also some concern if the framework is too complex. How strong the framework is remain to be seen.