The Economy‐wide Impacts of a Rise in the Capital Adequacy Ratios of Australian Banks

Abstract

Regulators are requiring banks to raise additional equity to finance their activities. The benefits are understood in terms of reducing the risks of another financial crisis. But there are potential costs, including the potential for unanticipated macroeconomic impacts as banks reduce leverage. We use a financial computable general equilibrium model, containing disaggregated treatment of financial agents, to explore the economy‐wide consequences of an increase in bank capital adequacy ratios. We find that the macroeconomic consequences are small.

Comparing the Impacts of Financial Regulation in Australia and the United States via Simulation with Country-Specific Financial CGE Models

“…In this section we provide a summary of the USAGE2F model used in the simulations described in Section 3. For a detailed discussion of the financial part of the USAGE2F model, we refer the reader to Dixon et al (2015) and Giesecke et al (2016). As we shall describe, the FCGE model is based on identification of many agents and the optimising behaviour governing their actions.…”

“…Second, we must activate theory that allows movements in the capital adequacy ratio to affect the amount of equity that banks hold on the liability side of their balance sheets. We expand below, following a similar approach to that in Giesecke et al (2016).…”

“…We explore this question herein, by comparing the macro-and industry-level impacts of heightened bank capital adequacy regulations in the U.S. and Australia. We model the capital adequacy ratio and its impact on the behaviour of the commercial banks in the U.S, using a similar approach to that adopted for the Australian economy by Giesecke et al (2016).…”

“…As we outline in section 3, this is achieved by developing two business-as-usual (BAU) baselines for USAGE2F, with capital adequacy constraints on commercial bank behaviour in place that mirror those in Giesecke et al (2016). In the first baseline (BAU1), the capital adequacy ratio and risk weights are set at business-as-usual levels.…”

“…First, we explore the costs of financial regulation in the U.S. by analysing the differences in outcomes for important policy variables (e.g., real GDP, employment, consumption, investment) in BAU2 relative to BAU1. Next, with the regulatory framework adopted under BAU1 and BAU2 in USAGE2F similar to those used to study the impact of financial regulation in Australia by Giesecke et al (2016), we compare our findings with those in Giesecke et al (2016) for Australia. This allows us to decompose differences in the macroeconomic implications of changes in the capital adequacy of domestic commercial banks into two parts: (1) variations driven by dissimilarities in the real economies of each nation; and (2) differences in their respective financial structures.…”