Article Review: Bank Regulations and Macroeconomic Essay
Nevertheless, here were no banking crises since the banking system was being kept under tight credit controls. Therefore, the bank regulation was light. This also helped to maintain the unemployment rate below the natural rate. In the decade of the asses, stagflation occurred, and contraction monetary policy was required to lower the level of inflation. This shows evidence how the banks can really affect the economy of a nation, or even the world, through their parameter. In 1988, the Basel Committee on Banking Supervision (BBS, initially called the Blunder and then the Cooke Committee), has introduced the Accord on Capital
Adequacy Requirements, which is known as Basel I nowadays. In 2004, the committee has introduced another Accord, which is known as Basel II. Basel II is a revised edition of regulatory framework and it is being used currently. Basel II adopts a “three pillars” concept, which consists of three major aspects: (I) Minimum capital requirement, (it) Supervisory review, and (iii) Market discipline. In the viewpoint of regulator, banks should hold a certain amount of capital in order to operate. As required by Basel II, a minimum of 8% of total capital ratio should be possessed by the banks.
There are three types
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This grants chance for depositors and redirectors to use the information given to appraise the level of risk and make investment decisions. Apart from Basel Accord, there are several other regulations for banks, such as reserve requirement, corporate governance, financial reporting and disclosure requirements, credit rating requirement, large exposure restrictions and activity and affiliation restrictions (Wisped, 2013). Reasons tort the Research How do the bank regulations influence the economy? This perhaps would be the major concern of Goodhearted et al.
There are numerous reasons why the researches would like to investigate this issue. First of all, the effect of bank regulations on the economy could be considerable. For instance, Miss Tanana (2003) points out that since Basel II has become more risk-sensitive, banks would perhaps tend to lend to companies which have renowned reputation and sound financial background. Small and medium enterprises (Seems) might have less chance to be granted the credit as they have little access to market-based finance and have higher capital requirements.
Consequently, their investment and production might decline. Several countries in which their financial systems are based on the banks, such as Germany ND Japan, might have dilemma as most companies in these countries are bank- dependent and need bank loans. Secondly, the researchers would like to identify the efficacy of Basel II, which is still freshly introduced to financial institutions at the moment. Basel II has become more risk-sensitive and this leads banks to have less exposure on risks. Basel II can also help banks to perk up their internal risk management abilities.
However, Federal Reserved Bulletin (2003) has stated out three hurdles financial institutions might have when adopting the Basel II: cost of implementation, viable equity and treatment f operational risks. Researchers would like to investigate whether the benefits provided by Basel II could be offset by its weaknesses. Research Topic and Research Questions The research questions for this article is “Would the bank regulations affect the macroeconomic fluctuations? ” This research question can be easily adapted from the topic itself. This article of Goodhearted et al. 2004) evaluates the relationship between bank regulation and macroeconomic fluctuation. According to Spoon (2000), bank regulations are carried out to protect depositors, ensure monetary and financial debility, promote efficient and competitive financial system, and protect customers. Prolific, according to Investigated, is a situation which the relationship between a good, service, or economic indicator and the general circumstance of economy is positive. In other words, when the economy is bullish, the value of good, service or economic indicator boosts. The converse is also true.
Continuous practicality leads to fluctuation. As stated by Goodhearted et al. (2004), there was assumption that there is connection between macroeconomic cycles and the boom-bust cycles in bank lending and asset prices. This has endorsed many researchers; embrace Goodhearted et al. , to do research on the ambiguous association. Hypothesis and Variables of Research The hypothesis that can be found in this article is quite subtle, that is, bank regulations can affect the macroeconomic fluctuations. Under this hypothesis, the researchers have displayed three arguments which might help them to support their hypothesis testing.
The first argument is liberalizing of banking sector prompts the practicality of financial system. The second argument is regulation of bank capital in term of capital adequacy requirements is itself naturally prototypical, and may intensify business-cycle fluctuations. The third argument is Basel II accord is an instrument that emphasizes the practicality of the regulatory system. The independent variable for this research is the bank regulations, while the dependent variable tort this research is the macroeconomic utilizations. The result to the research is explained in term of both theoretical and empirical.
Test Implications and Research Design There are three assumptions that the researchers would like test for their validity. The first assumption is practicality of financial system could be encouraged through liberalizing of banking sector. The second assumption is capital adequacy requirement, which acts as regulation of bank capital, is prototypical and may magnify business-cycle fluctuations. The third assumption is Basel II highlights the practicality of regulatory system. (I) The First Assumption Researchers would like to look on the prototypical implications of financial liberalizing.
Based on Figure 2 in page 603, it shows the unsighted country average of the development of real GAP growth, the change in real property prices, the change in real bank lending, and change in real share prices in the 10 years subsequently from financial liberalizing. This figure is attached with upper quartile and lower quartile. The researchers take 16 COED (Organization for Economic Co- operation and Development) countries as the sample for this experiment: Australia, Belgium, Denmark, Finland, France, Ireland, Italy, Japan, Korea, New Zealand, Norway, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
Real GAP, bank lending, property prices, and share prices after financial liberalizing of each nation are collected, and the average figures of these four variables are taken. The experiment shows that fluctuations in economic activity, bank lending as well as asset rises are highly linked with the liberalizing of financial sector. As more quarters after financial liberalizing elapse, there are many boom-bust cycles within the real bank lending, real property prices and real share prices. To further validate their first assumption, Goodhearted et al. Aka another experiment on sensitivity of bank lending to property-price movement as a result of financial liberalizing. This time, the researchers carry out Ordinary Least Squares (LOS) for testing the experiment. A sample of 10 COED countries (Australia, France, Italy, Japan, New Zealand, Norway, Sweden, Switzerland, the United Kingdom and the United States) over a progressing period of 1 5 years with quarterly data is collected. In the end, the result in Figure 3 (page 604) supports the statement that bank lending has become more sensitive to property price after realization of financial liberalizing. It) The Second Assumption There are three experiments under this section to verify the second assumption. The first experiment is to determine the relationship between the capital-asset ratio (CAR) and its components (change in regulatory capital as numerator; change in risk- weighted assets as denominator) for commercial banks in United States. Figure 4 unveils that an increase in regulatory capital and a decline in risk-weighted assets instigate CAR to grow. The researchers suggest that growth in CAR may have caused cutback in credit supply to the economy, which will affect the economy adversely.
The second experiment inherits the concept of the first experiment under this section. The second experiment clarifies how credit creation affects economic activity in United States. Figure 5 presents the progress of real GAP growth and nominal lending progression in Nun De t States since 1965 Clearly, the graph snows the positive relation between economic activity in United States and credit creation. Three recessions aroused in United States (1974/5, 1980/2, and 1990/1) are due to retardation of credit creation.
The third experiment explains the relationship between prime lending rate and federal funds rate in United States, from 1980 to 2003. This experiment is supported by the standard augmented Dickey-Fuller (UDF) unit-root test (Table 2, page 607). Based on Figure 6 (page 607), researchers have unanimous opinion that the supply effect on the credit market is negative if the spread of the prime rate over the federal funds rate rises. This happens during the interval 1990-1991, that is after the introduction of capital adequacy requirements to the US credit market.
From the three experiments, we can conclude that the capital adequacy requirement promotes practicality. (iii) The Third Assumption How Basel Accord II would change the operations of “typical” bank? This is the statement that the researchers would like to test for. In this test, researchers have selected three countries: Mexico, Norway and Unites States, applying three different regulatory approaches. They are (I) the Basel II standardized approach, (it) the Basel II Foundation Internal Ratings Based (RIB) approach, and (iii) an improved credit risk method (CRM).
For this experiment, researchers would see whether Basel II RIB approach can highlight the practicality of the regulatory system. From the experiment, researchers have found that variance of the virtual results for the RIB is greater than for the standardized or CRM approaches. Besides that, percentage change in the required CAR under the RIB in terms of practicality is more tremendous than the other two approaches, as shown in Table 6 (page 613). This shows that Basel II could promote the practicality. Sampling Methods Sampling methods are not mentioned clearly by the researchers.
However, we could still identify their sampling techniques based on their experiments. The first method is Judgment sample. The researchers believe that the members can best represent the population. In this case, researchers have applied three countries, which are United States, Mexico and Norway to find the effect of Basel II on practicality. Only countries in which Moody’s data on credit ratings have a long enough time series are selected to verify the third arguments. Most European countries have been excluded due to insufficient credit rating data. The second method is convenience sampling method.
Samples are chosen as they are readily available. Data of 16 COED countries about real GAP, bank lending, property prices, and share prices can be adapted from the authorized party, or even from the Internet. Besides that, data of CARS of Mexico and Norway are collected from the Mexican Financial Regulatory Agency and the Norwegian Central Bank on Corporate Loans. The third method is case study method. According to Wisped, this kind of sampling method is limited to only one group. For instance, only commercial banks in United States are selected to verify the second argument.
Thus, the result obtained perhaps can Just represent the United States. Representatives of Sample and Fairness of Research For the first argument, samples can adequately represent the population. 16 COED countries have strong influence on the world economy, and the results obtained are quite reliable. Therefore, the argument that liberalizing to banking sector prompts the practicality of financial system could be an index for regulatory body. For the second argument, sampling method are only limited to commercial banks of the United States.
This experiment has omitted other commercial banks from other Mounties or regions, like United Kingdom, Rezone, Japan, and Australia. The samples assigned, therefore, could not sufficiently represent all the commercial banks apart from the United States. However, the second argument could be verified with using samples in the United States. For the third argument, researchers have bound in collecting the data from most of the European countries, since credit rating data of European countries are newly released when researchers have started their work. Therefore, they have to use the data from Unites States, Norway, and Mexico.
The samples can Just fairly represent the population. Nevertheless, their third argument could be accepted after the experiments on CARS value. Overall, the research is quite biased, as developing countries and underdeveloped countries are not included in the samples. Moreover, this research is quite bias towards Unites States, and even not every COED countries are selected for being samples for the experiment. Since the research explores on the macroeconomics (economy as a whole), more developing countries, and perhaps some developed or underdeveloped countries need to be given emphasis. China, Germany, Singapore and United Arab Emirates (U.
A. E. Should be included as these countries can also affect the global economy. Differentiation in Samples for Experiments For the first argument, the samples, which are COED countries, can already best represent the population. However, the study can also be repeated by using several regions, like Rezone countries, Asian countries and Middle East countries. The integration data for all the regions should be obtained to present a fair study result. For the second argument, it is better to have more country samples in the experiment. The result obtained would be more reliable and effectively represent the population.
Should the number of sample is remained, countries like United Kingdom, France, Germany, and Japan can become the replacement. For the third argument, the result of study would be more reliable if the number of samples compared is more, for example, 20 or above. The study done by the researchers to verify the third argument can Just fairly represent the population. Other COED countries which have not been included in this experiment, as well as other non- COED nations, can also be tested for verification of the third argument. However, the new samples must have CARS values for Basel II standardized approach, Basel II
Foundation Internal Ratings Based (RIB) approach and improved credit risk method (CRM), before the samples could be chosen for the experiment. Evaluation on Arguments and Conclusion From this research, hypothesis that bank regulations will affect the macroeconomic fluctuation has been supported by three arguments. The three arguments have been validated by several experiments done. The hypothesis proposed is correct. In the conclusion of the research, researchers once again emphasize the three arguments that promote the practicality, which are on financial liberalizing and capital adequacy requirements.
The researchers state that the increase in risk-sensitivity in capital adequacy requirements makes macroeconomic cycles happen more frequent. However, the researchers warn readers that the adoption to Basel II maybe deteriorate the future capital fluctuations. So, researchers have suggested that an analysis on the contra-cyclical should be made in future. References Exchanging, B. , ; Bored, M. (2003). Crises Now and Then: What Lessons from the Last Era of Financial Globalization. Monetary History, Exchange Rates and Financial Markets; Essays in Honor of Charles Goodhearted, 2, 52-91.