Editorial : Do Risk - Adjusted Pricing and the New Basel Capital Accord Reinforce the Credit Cycle ?

The Basel Committee for Banking Supervision recently drew a great deal of attention when they published their proposal for a New Basel Capital Accord (2001). Among the critisism, praise, and numerous responses it generated, one aspect was given very little attention: the credit cycle. Traditionally, credit had been granted at the same or very similar conditions to all the credit applicants who qualified. As a consequence, lending volume was pro-cyclical. During times when the economy was strong, many candidates were able to meet the qualification criteria and credit volume increased, its rate of increase often exceeding economic growth by a good margin. On the other hand, during recessions, fewer candidates qualified, and therefore credit volume shrank. In extreme cases, a credit crunch resulted. Increasing lending during growth times tends to stimulate further growth, decreasing lending to exacerbate a recession. Pro-cyclical bank lending is therefore considered harmful to economic stability. Another consequence of the traditional lending ways was the subsidizing of higher-risk debtors by lower-risk debtors.