A Model of Bank Capital, Lending and the Macroeconomy: Basel I Versus Basel Ii*

Abstract

The revised framework for capital regulation of internationally active banks (known as Basel II) introduces risk-based capital requirements. This paper analyses the relationship between bank capital, lending and macroeconomic activity under the new capital adequacy regime. It extends a model of the bank capital channel of monetary policydeveloped by Chami and Cosimano-by introducing capital constraints à la Basel II. The results suggest that bank capital is likely to be less variable under the new capital adequacy regime than under the current one, which is characterized by invariant asset risk-weights. However, bank lending is likely to be more responsive to macroeconomic shocks. * This paper represents the views and analysis of the author and should not be thought to represent those of the Bank of England. I would like to thank Ralph Chami, Charles Goodhart, Glenn Hoggarth, Erlend Nier, Hyun Song Shin, Dimitrios Tsomocos, Geoffrey Wood, seminar participants at the Bank of England, and an anonymous referee for helpful comments. I am, of course, responsible for any remaining errors. 1 1(2) 7 Tier 1 capital is the book value of a bank's stock plus retained earnings. Tier 2 capital is the sum of loan-loss reserves and subordinated debt.Bank Capital, Lending and the Macroeconomy 53

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