How can the change of Basel Capital Requirements affect the Monetary Policy Impact on the Iranian Economy and Banking System?

In this study, we examined the effects of monetary policy shocks on the performance of the Iranian macroeconomy and the banking system, under the different situations of the Basel II and III capital requirements regulations. By developing a DSGE Model and according to its structural shocks, four observable variables including output gap, bank capital adequacy, inflation, and money base growth rate during the period from 2004Q1 to 2020Q4 were included in the Bayesian estimation process along with some other predetermined parameters. Lastly, the impulse-response functions of the model were interpreted in two scenarios Basel II or III to the capital adequacy ratio. The results show that if banks operate under the Basel II capital regulations, the central bank’s use of money supply may lead to low growth in the economy in the short-run, but in the medium- and long-run, the negative effects will be much larger. However, with the introduction of Basel III regulations for banking business, the output fluctuations will be reduced by the enlargement of the money supply. The results also show that a shock to the money supply leads to a harsh increase in inflation, and it is remarkable that the introduction of Basel II or III does not affect the nature of the inflation response to monetary policy. Finally, we found that in both scenarios of the introduction of Basel II and III due to a monetary policy shock, bank profitability falls abruptly in the short run.