This paper proposes replacing the present Basel capital requirement with a new counter-cyclical measure. Optimally, (i) the Basel capital requirement ratio should depend on various economic factors such as the cyclical stage of GDP, credit growth, stock prices, interest rates, and land prices—hence, avoiding the expansion of bank loans during a boom period and a credit crunch during a sluggish period; (ii) the Basel minimum capital requirement rule should be different from country to country since the economic structures and the behavior of banks are different; and (iii) cross-border bank operation should follow the minimum capital requirement ratio where bank lending activities occur rather than the origin of the source of funds.

The current paper is based on Yoshino, Hirano, and Miura (2009) and has benefitted from various comments made by Ryozo Himino (FSA, Japan), and seminar participants at IMF (Washington CD), Basel (Hong Kong Office), Asia Economic Forum (Beijin, Central University of Finance and Economy), and DIC conference (Deposit Insurance Corporation) held in Tokyo. Conclusions are the authors' and do not reflect FSA's view.

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© 2011 The Earth Institute at Columbia University and the Massachusetts Institute of Technology
2011