Abstract
This paper examines the procyclical effect of risk-sensitive capital regulation on bank lending. We find evidence that the sensitivity of bank lending to GDP is significantly positive under the internal rating-based approach. Our findings show that the risk-sensitive requirements of the Basel II and III regulations have procyclical effects on bank lending in nine European countries. The introduction of the risk-sensitive capital requirement rule negatively impacts lending in these countries. The policy implication is that regulators should place greater priority on building a buffer in advance, which can be used in times of stress rather than for dampening excess cyclicality.
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