How Has the Basle Accord Affected Bank Portfolios?

Abstract

This paper investigates the extent to which the risk-based capital standards, which took effect in 1989, have affected commercial bank portfolios. The new standards give banks an incentive to substitute away from loans, which have a high risk weight, into less risky assets such as government securities. Time-series macro data is used to determine whether the risk-based guidelines have caused unusually large portfolio changes on bank balance sheets. Bank-level data are used to determine how successful banks have been in meeting their capital requirements and to explore the relationship between capital ratios and subsequent portfolio shifts. The principal conclusion of this paper is that both the timing of bank portfolio shifts and the strong relationship in the bank-level data between low risk-based capital ratios and portfolio adjustment (controlling for the ratio of bad loans to assets) are consistent with the view that the risk-based capital standards have significantly affected bank portfolios. During the 1990 and 1991 period, banks were quite successful in raising their capital ratios in order to meet the risk-based capital requirements. However, in order to raise capital ratios, banks decreased lending, particularly to businesses. The evidence suggests that commercial banks have reduced their loans by approximately $150 billion because of the risk-based capital guidelines. To the extent that a "credit crunch" has weakened economic activity since 1990, Basle-induced declines in lending may have been a major cause of this credit crunch. J. Japan. Int. Econ., December 1993, 7(4), pp. 408–440. Department of Economics, Harvard University, Cambridge, Massachusetts 02138.