Can the transition from Basel II to III change the monetary policy impact on the Iranian economy and banking system?

Abstract

Using a dynamic stochastic general equilibrium (DSGE) model, we analyzed the impact of the Basel II and III capital requirements regulations on the effects of monetary policy shocks on the behavior of the macroeconomy and the Iranian banking system. According to the structural shocks, four observable variables including output gap, bank capital adequacy, inflation and money base growth rate during the period from 2004Q1 to 2020Q4 were included in the Bayesian estimation process along with some other predetermined parameters. Finally, the impulse-response functions of the model were interpreted in two scenarios Basel II or III to the capital adequacy ratio. The results suggest that if banks operate under the Basel II capital regulations, the central bank’s use of money supply may lead to low growth in the economy in the short-run, but in the medium- and long-run, the negative effects will be much larger. However, with the introduction of Basel III regulations for banking business, the output fluctuations will be reduced by the expansion of money supply. The results also show that a shock to the money supply leads to a sharp increase in inflation, and it is noteworthy that the introduction of Basel II or III does not affect the nature of the inflation response to monetary policy. Finally, we found that in both scenarios of the introduction of Basel II and III due to a monetary policy shock, bank profitability falls sharply in the short-run. However, with the adjustments that the bank makes to interest rates, it quickly returns to profitability.