Banking Regulation Basel II

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Procyclicality in minimum regulatory capital charges for credit risk
There is a vast amount of literature available on the additional procyclicality of regulatory capital charges in Pillar 1 of Basel II. In this section, we shall briefly visit this literature and see if any conclusions can be drawn from this, before proceeding to the conclusion and mitigation of these procyclical effects. The majority of the literature, as expected, focuses primarily on the IRB approach, as this aspect of Basel II has drawn the most criticism from financial practitioners and academics alike. The greater part of this literature has found that there is an overwhelmingly substantial rise in procyclicality of minimum regulatory capital charges originating
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This is the biggest problem, and has to be addressed correctly once economic conditions are conducive to do so. Within the specified Tier 1 requirement, common shares and retained earnings should be a priority and form the predominant form of capital. To ensure the quality of this capital, the Basel Committee should harmonize capital deductions and prudential filters (FSF & BCBS, 2009). The committee should also enhance the disclosure of the components of regulatory capital in order to increase transparency within the system and avoid confusion in terms of the quality of capital required.
(2) The Basel Committee should make adjustments to their framework to inhibit excessive cyclicality of the minimum capital requirements
The Basel Committee has made a reasonable effort to mitigate this cyclicality already, by monitoring the impact of cyclicality through data collection (via their Capital Monitoring Group). This data is available every 6 months, and helps the committee monitor the extent to which the capital regime reveals excessively high levels of capital cyclicality. In correspondence with this data monitoring, the Basel Committee must review the ways in which cyclicality, arising from the Pillar 1 capital requirement calculation, can be abated. They must try and maintain the risk sensitivity of the inputs, but also create an emphasis on dampening the effects of cyclicality on the outputs. This way the
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