The Basel Accord and Financial Intermediation: The Impact of Policy

How can a central bank influence the availability of credit through the business cycle? Banks limit the loans they offer because (1) the loans may not provide a sufficient return; (2) the loans are too risky; (3) interest margins are too low; (4) there are regulatory constraints; and (5) there is a lack of funds. The literature on financial intermediation traditionally has neglected the last two points, especially the lack of funds. With this article, we take better account of the funding of banks and how it interacts with the two policy tools available to the central bank: monetary policy through the adjustment of some interest rates and regulatory policy through the variation of capital requirements. We find that monetary policy matters most in terms of expectations. Indeed, the fact that the central bank commits to act in certain, possibly rare, situations is more important than the action itself. Households have a saving pattern that is more favorable to aggregate credit This article studies loan activity in a context where banks have to follow Basel Accord–type rules and find financing with the households. Loan activity typically decreases when investment returns of entrepreneurs decline, and we study which type of policy could invigorate an economy in a trough. The authors find that an active monetary policy increases loan volume even when the economy is in good shape, while the introduction of an active capital requirement policy is also effective if it implies tightening of regulation in bad times. This is performed with a heterogeneous agent economy with occupational choice, financial intermediation, and aggregate shocks to the distribution of entrepreneurial returns. (JEL E44, E22, G28, E58)