We show how banks' excessive risk-taking, stemming from informational asymmetries in loan markets, can lead to an excessive output loss when a recession starts. Risk-based capital requirements can alleviate the output loss by reducing excessive risk-taking in ‘normal' times. Model simulations...

Policy discussions on the recent financial crisis feature widespread calls to address the pro-cyclical effects of regulation. The main concern is that the new risk-sensitive bank capital regulation (Basel II) may amplify business cycle fluctuations. This paper compares the leading alternative...

The amplification of swings in economic cycles in recent decades has led to more instability in the financial system. This pushed for changes in prudential regulation and risk management practices in an attempt to reduce the pro-cyclicity of regulatory regimes.This paper examines the new...