The design of the risk-sensitivity of capital requirements: does it matter for bank business choices?

By employing cross-country variations in the adoption of the Basel I and II capital Accords, we examine how different designs of the risk-sensitivity of capital requirements influence bank business choices. We show that the move to the Basel II regime has not amplified the trends found for the Basel I Accord in the form of a reduction in total lending growth (asset substitution), and increases in lending risk (cherry picking) and noninterest income activities (activity substitution). In fact, Basel II has led to a reduction in bank exposure to non-interest income and, at least in the case of banks opting for the high risk-sensitive Internal Rating Based (IRB) option within Basel II, decreased lending risk. Nevertheless, the adoption of the IRB approach has had the negative consequence of lowering the growth rate of loans to the corporate sector and amplifying its procyclicality.