Basel II and Banking Behavior in Local Markets
23 Pages Posted: 21 Jan 2009
Date Written: January 20, 2009
Abstract
The paper deals with the effects of the new capital requirements (Basel II) on banking behaviour. Since the core of the new rules is the greater sensitivity of regulatory capital to the borrowers' risks, we investigated whether banks react to the new rules by differentiating their lending behaviour accordingly. Our theoretical conclusions indicate that as banks switch from Basel I to Basel II rules, they reallocate loans from high-risk to low-risk borrowers, while making interest rates more sensitive to probability of default. An econometric study using Italian data supports both these conclusions. Specifically, we find that as banks adapt to Basel II interest rates on loans do become more sensitive to default risk. In addition, an increase in the interest rate reduces the availability of credit in Southern regions, but increases it in the Centre-North. These results suggest that under Basel II higher-risk firms are likely to pay more for loans, and that firms located in the South are likely to be more severely affected.
Keywords: Risk-based capital, Basel II Accord, Credit allocation
JEL Classification: G21, G28, E43
Suggested Citation: Suggested Citation