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We test the hypothesis that credit quality deteriorates during credit booms. The test case is a pronounced cycle in connection with a banking crisis, ranked among the most extreme in international studies. A unique data set allows us to rate household borrowers during the cycle, and aggregate the ratings to the macroeconomic level. The post-crisis period is also studied to find changes in credit quality.

The method reveals significant variation in average ratings of household borrowers during the crisis cycle and its aftermath. We find that ‘point-in-time’ ratings, calculated with realised data, do not indicate deterioration in average credit quality during the credit boom. In contrast, ‘through-the-cycle’ ratings, constructed by using data that is cleaned from cyclical variation, behave in accordance with the hypothesis. By all measures used, a significant improvement in the average quality of borrowers is found during the post-crisis period.

This chapter examines the increased levels of cross-asset price comovement and its relationship with the recent rounds of “extraordinary intervention” from the US Federal Reserve. The results show that, even after controlling for the preceding financial crisis, asset return volatility, investor risk perceptions, and channels of monetary stimulus, historically unrelated financial asset returns experienced abnormal changes in their conditional correlations. The strength of these cross-asset correlations is directly linked to periods of Federal Reserve interventions yet disappear when the interventions were (in fact or were perceived to be) withdrawn. Despite being studied extensively in the academic literature, no traditional intervention channels can explain the changes in cross-comovement. It is proposed that the Fed’s extraordinary stimulus caused investors to use Fed announcements as a common, low-cost information source on which they used to make common portfolio-allocation decisions. The changes in comovement during the intervention period may have reduced investor welfare for those with longer-horizon allocation strategies, those not prepared for the eventual ending of the stimulus, and for underfunded liability-optimizing portfolio managers (e.g., state pension funds).

To raise the quality of regulatory capital, Basel III capital rules recognize unrealized gains and losses on all available-for-sale (AFS) securities in Common Equity Tier 1 Capital (CET1). However, by examining the correlations between U.S. GDP growth rate, interest rates and regulatory capital ratios computed using Basel III regulatory capital definition for six U.S. global systemically important banks (G-SIBs) since 2007, this chapter finds that Basel III regulatory capital will enhance the pro-cyclicality of Basel III leverage ratio and Tier 1 capital ratio and their sensitivity to long-term interest rates. Therefore, Basel III capital standards may have significant implications for bank supervision and bank capital risk management in the near future. As banks will hold more high-quality liquid assets (HQLAs) as required by Basel III Liquidity Coverage Ratio (LCR), the weight of unrealized gains and losses arising from fair value accounting will increase in Basel III Tier 1 capital base, the consequent increase of pro-cyclicality in a bank’s regulatory capital ratios may distort the true picture of bank capital adequacy. If an expected loss approach (EL) is used as the provisioning model, such capital risk may be increased further. Moreover, as U.S. monetary policy has started tapering quantitative easing, long-term interest rates will increase inevitably. This may increase the negative impact of unrealized gains and losses on AFS securities on bank capital. As a result, it may be difficult for banks to maintain appropriate capital ratios to meet regulatory requirements and support business activities.

This chapter considers financial instability as a phenomenon endogenous to the functioning of capitalism. Consequently, it seeks to identify the main sources and different forms of the latter in financialised capitalism. According to Keynes, capital assets prices are conceived as the expression of financial conventions. It is, therefore, important to distinguish between the returns expected by company directors, bankers, holders of equity titles, risk-takers and, in contrast, risk-averse holders of debt securities. Minsky enriches the analysis by attributing a decisive role to the leverage effect, at the origin of an accumulation of financial weaknesses in the balance sheets of non-financial agents during the expansion phases preceding financial crises. Regulation theory leads to the introduction of a distinction between the financial accelerator and the leverage effect. The first establishes a procyclical relationship at the macroeconomic level between the price of capital assets and the debt ratio of non-financial agents; the second acts at the microeconomic level through shareholder corporate governance, which determines the institutional conditions inciting firm directors to integrate shareholder expectations into their return forecasts. The empirical analysis identifies three forms of financial instability in financialised capitalism: the long-term financial cycle governed by the debt ratio of non-financial agents; the business cycle governed by the impact of stock prices on investment; and the short-term or even very short-term expected return revisions of financial actors. Its originality is to show that these three forms of instability acquire different characteristics depending on the national economy considered.

Purpose – To discuss, from the perspective of developing countries, recent proposals for reforming international standards for bank capital requirements.

Methodology/approach – After evaluating, from the viewpoint of developing countries, the effectiveness of capital requirements reforms and progress in implementing existing regulatory accords, the chapter discusses the procyclical effects of Basel regimes, and suggests a reform proposal.

Findings – Minimum bank capital requirements proposals in developing countries should be complemented by the adoption of an incremental, size-based leverage ratio.

Originality/value of chapter – This chapter contributes to enlarge the academic and policy debate related to bank capital regulation, with a particular focus on the situation of developing countries.

This chapter sheds new light on the linkages between stock market fluctuations and business cycles in Asia. It shows that at cyclical frequencies stock markets lead business cycles by six months on average. China, Korea, and Taiwan constitute exceptions, as their real and stock market cycles are contemporaneously synchronized. The low level of maturity of these markets offers a potential explanation of this outcome. Furthermore, we find that the linkage also holds during phases of cyclical upswing and downturn, with the exception of China, where the financial market lags behind industrial production during expansions. Finally, for most of the countries (except Thailand and Malaysia), the linkage is also robust to the presence of financial crises.