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LUND UNIVERSITY LIBRARIES

BASEL III: The effect that Capital requirements have on interest rate margins

Eriksson, Alexander LU (2013) NEKH01 20131
Department of Economics
Abstract (Swedish)
The Basel III regulatory framework was created in direct response to the financial crisis that occurred in 2007-2008. The regulatory framework in place during and before the crisis, Basel II, had not done enough to prevent the crisis. This prompted a revision and expansion of the regulations. The regulators created a new framework, which was initiated in January of 2013 and is expected to be fully implemented by 2019. Basel III expands the capital requirements already in place in Basel II. These increases in capital requirements will have an effect on the profitability of the banks. According to the Modigliani-Miller (MM) theory, increases in equity will reduce the banks’ return on equity (ROE). If the ROE of the banks are falling, the... (More)
The Basel III regulatory framework was created in direct response to the financial crisis that occurred in 2007-2008. The regulatory framework in place during and before the crisis, Basel II, had not done enough to prevent the crisis. This prompted a revision and expansion of the regulations. The regulators created a new framework, which was initiated in January of 2013 and is expected to be fully implemented by 2019. Basel III expands the capital requirements already in place in Basel II. These increases in capital requirements will have an effect on the profitability of the banks. According to the Modigliani-Miller (MM) theory, increases in equity will reduce the banks’ return on equity (ROE). If the ROE of the banks are falling, the increase in capital requirement will not have large effects on the lending margins, but there will be an increase in tax expenditure for the bank. There is, however, some distortion to the MM theory, as the implicit guarantees provided by the government will cause the banks to try to maintain their ROE.

This study used the method of King (2010) to create a model bank, using the annual reports of 2011-2012 for the 4 major Swedish banks. Using this model bank, a simulation on how a 1pp increase in total capital requirements will impact ROE. The objective is to identify by how much the banks need to increase their lending spread in order to maintain their pre capital requirement ratio ROE. This study concludes that an increase in the lending spread by 7 basis points is needed to maintain the ROE when the banks increase their total capital ratio by 1pp. (Less)
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author
Eriksson, Alexander LU
supervisor
organization
course
NEKH01 20131
year
type
M2 - Bachelor Degree
subject
keywords
Basel III, Financial regulations, Interest margins, Sweden
language
English
id
4024833
date added to LUP
2013-09-17 14:37:39
date last changed
2013-09-17 14:37:39
@misc{4024833,
  abstract     = {The Basel III regulatory framework was created in direct response to the financial crisis that occurred in 2007-2008. The regulatory framework in place during and before the crisis, Basel II, had not done enough to prevent the crisis. This prompted a revision and expansion of the regulations. The regulators created a new framework, which was initiated in January of 2013 and is expected to be fully implemented by 2019. Basel III expands the capital requirements already in place in Basel II. These increases in capital requirements will have an effect on the profitability of the banks. According to the Modigliani-Miller (MM) theory, increases in equity will reduce the banks’ return on equity (ROE). If the ROE of the banks are falling, the increase in capital requirement will not have large effects on the lending margins, but there will be an increase in tax expenditure for the bank. There is, however, some distortion to the MM theory, as the implicit guarantees provided by the government will cause the banks to try to maintain their ROE. 

This study used the method of King (2010) to create a model bank, using the annual reports of 2011-2012 for the 4 major Swedish banks. Using this model bank, a simulation on how a 1pp increase in total capital requirements will impact ROE. The objective is to identify by how much the banks need to increase their lending spread in order to maintain their pre capital requirement ratio ROE. This study concludes that an increase in the lending spread by 7 basis points is needed to maintain the ROE when the banks increase their total capital ratio by 1pp.},
  author       = {Eriksson, Alexander},
  keyword      = {Basel III,Financial regulations,Interest margins,Sweden},
  language     = {eng},
  note         = {Student Paper},
  title        = {BASEL III: The effect that Capital requirements have on interest rate margins},
  year         = {2013},
}