The Real Impact of Basel Ratings-Based Capital Rules on the Finance-Growth Nexus

Abstract

We investigate whether ratings-based banking regulation introduced under the Basel capital framework has had any impact on the finance-growth nexus via the foreign credit channel. Using data on GDP growth per capita and cross-border bank lending to 77 countries between 1999 to 2013 we find that since the implementation of Basel 2 capital rules, risk weight changes mapped to sovereign credit rating revisions have exerted a more significant effect on economic growth in both recipient and lender countries. We also find direct evidence to indicate that the practice of global banks in increasing their foreign lending to investment grade sovereigns given their lower risk-weights has contributed to lower economic growth in these recipient countries. However, the adverse effects of the Basel capital rules are ameliorated in the presence of more open financial markets with better developed banking systems.