681 - When Basle II doesn’t work: Contingency Rules versus Fixed Requirements

Wetenschappelijke publicatie
Date 1 February 2002

Under the new Basle Capital Accords, regulation takes the form of a contingency rule prescribing a certain level of bank capital contingent on the bank’s risk taking behaviour in choosing its asset portfolio. In a simple dynamic model of banking with binding regulation we show that such Basle II regulation is Pareto inferior to regulation by a fixed capital requirement if and only if some condition on elasticities is satisfied. We provide a simple example to illustrate our findings. Keywords: capital adequacy requirements, contingency rules, Basle II JEL Codes: E44, G28, L16