4.4 Policy Analyses
4.4.1 Macroprudential Regulation
In the following analyses, we discuss different regulatory regimes, depending on the degree of shadow bank consideration. We therefore implement, in the estimated Basel II model, different types of regulators that follow countercyclical rules for adjusting commercial bank capital requirements. We take key elements of the Basel III framework into account: countercyclical adjustment of capital requirements in response to swings in the credit cycle and the primary focus on commercial banking in the application of macroprudential policy. As indicated above, before the implementation of Basel III, the requirement on total capital holdings was 8 percent, and no countercyclical adjustment of requirements
29We conducted a sensitivity analysis to evaluate the robustness of the estimation and found that model
Macroprudential Regulation and Leakage to the Shadow Banking Sector 64
was intended. We raise the steady-state capital requirement for all regulator types from 8 percent to 10.5 percent30 and change the capital requirement equation in the model from an exogenous AR(1) process to a regulation-specific countercyclical rule described in more detail below. We leave the rest of the calibration and estimated parameters unchanged, as they were derived from the estimation using the true regulatory setup and economic data before the implementation of Basel III.
We discuss two different versions of the Basel III macroprudential regulator – in ad- dition to the case without countercyclical capital regulation as under Basel II – that can apply capital requirements only to commercial banks, but cannot enforce regulation on the shadow banking system. The difference between these types emerges from the degree to which shadow banking is considered when setting capital requirements for commercial banks. We define amoderateregulator that only takes variation in commercial bank credit into account when setting capital requirements for commercial banks. In comparison, a
prudent regulator considers overall credit, which includes both commercial and shadow bank credit.31
We distinguish between four target variables that indicate the credit cycle: credit levels, credit growth, as well as the level and the growth rate of the credit-to-GDP ratio.32 The regulator thus raises the capital-to-asset ratio νC
t above the steady-state level of capital requirementsνC whenever the respective measure deviates positively from its steady-state value, and vice versa.
The Moderate Regulator
We first evaluate the policy setting of a moderate regulator that only focuses on develop- ments in commercial bank credit when setting capital requirements for commercial banks. The policy rules the moderate regulator follows in each scenario resemble the rule derived in Angelini et al. (2014) where deviations of the respective credit measure from steady state are targeted:
30The Basel III capital requirement consist of different buffers banks have to hold: 8 percent (minimum
Tier 1+2 capital) plus 2.5 percent (capital conservation buffer), yielding 10.5 percent for total capital.
31Under Basel III, the specific credit measure that should be applied is not stated explicitly in the
regulatory statutes, and the primary focus of regulators lies on credit intermediated by commercial banks.
32The choice of target variables is inspired by the common measures employed in the DSGE literature on
capital requirements. See for instance Rubio and Carrasco-Gallego (2016), Bekiros et al. (2018), Angelini et al. (2014), Angeloni and Faia (2013), and Christensen et al. (2011).
Credit Growth Rule: νtC = (1−ρν)νC + (1−ρν)χν∆BbtM +ρννt−C1+ενt (4.20)
Credit/GDP Growth Rule: νtC = (1−ρν)νC + (1−ρν)χν∆ZbtM +ρννt−C1 +ενt (4.21)
Credit Level Rule: νtC = (1−ρν)νC + (1−ρν)χνBbtM +ρννt−C1+ενt (4.22)
Credit/GDP Level Rule: νtC = (1−ρν)νC + (1−ρν)χνZbtM +ρννt−C1+ενt (4.23)
where b BtM =bE,Ct −bE,C b ZtM = b E,C t Yt − b E,C Y
and ∆ indicates the difference of a variable compared to its one-period lag. The reaction parameter χν determines the degree of policy sensitivity, and we calibrate it to a value of 7, which is broadly in line with the parameter values derived in Angelini et al. (2014). Furthermore, we allow for exogenous shocks ενt to the capital requirement, and assume an autoregressive shock process and smoothing in the adjustment of capital requirements, governed by parameter ρν which we calibrate at a value of 0.9.
The Prudent Regulator
In addition, a prudent regulator is introduced that takes lending by the shadow banking sector into account when setting capital requirements for commercial banks. Despite the lack of a unifying regulatory framework for shadow banks, we assume that the prudent regulator is able to derive estimates of non-bank credit intermediation. The regulator therefore considers not only commercial bank credit, but movements in overall credit.33 The policy rules stated in equations 4.20 to 4.23 are thus altered for the prudent regulator such that:
Credit Growth Rule: νtC = (1−ρν)νC + (1−ρν)χν∆BbtP +ρννt−C1+ενt (4.24)
Credit/GDP Growth Rule: νtC = (1−ρν)νC + (1−ρν)χν∆ZbtP +ρννt−C1+ενt (4.25)
Credit Level Rule: νtC = (1−ρν)νC + (1−ρν)χνBbtP +ρννt−C1+ενt (4.26)
Credit/GDP Level Rule: νtC = (1−ρν)νC + (1−ρν)χνZbtP +ρννt−C1+ενt (4.27)
33The ECB has stressed the importance to consider both commercial bank and overall credit in their
“scoreboard approach” for macroprudential regulation. See for instance Constâncio et al. (2019) for a review of the ECB’s approach towards macroprudential policy and the role of market-based finance in regulatory statutes.
Macroprudential Regulation and Leakage to the Shadow Banking Sector 66
where
b
BtP = (bE,Ct +btE,S)−(bE,C+bE,S)
b ZtP = b E,C t +b E,S t Yt − b E,C +bE,S Y .