Bank Regulation and Macroeconomic Fluctuations

Abstract

Over the last two decades, macroeconomic cycles were frequently associated with boom-bust cycles in bank lending and asset prices, often followed by financial instability. In this paper we argue that (i) the new pattern of macroeconomic cycles is partly the result of banking-sector liberalization since the early/mid-1970s, which has increased the procyclicality of the financial system; (ii) the regulation of bank capital in the form of capital adequacy requirements is itself inherently pro cyclical and may therefore amplify business-cycle fluctuations; (iii) the new Basel II Accord may considerably accentuate the procyclicality of the regulatory system.