Adjustment costs, errors in risk weights, and banks' balance sheets: the 1988 Basel Accord revisited

Kevin Jacques, John Thornton, Elva Coadari
2010 Banks and Bank Systems  
Following implementation of the 1988 Basel Accord, U.S. banks altered their balance sheets in a variety of different ways including reallocating assets, reducing lending, and increasing capital. While much of the existing empirical research recognizes that fact, it fails to answer the question of why. In the context of a profit-maximization model that recognizes both non-homogeneous adjustment costs and errors in risk weights, this paper examines the question of why different banks exhibited
more » ... ferent responses to implementation of the 1988 Accord. The results suggest that banks with different loan and capital adjustment costs exhibited very different responses to implementation of the 1988 Accord. Furthermore, errors in calibrating the risk weights played a significant role in banks' balance sheet changes. The results are sufficiently robust to explain the sometimes contradictory findings of other researchers.
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