Rating systems, procyclicality and Basel II: an evaluation in a general equilibrium framework

The introduction ofBasel II has raised concerns about the potential impactof risk-sensitive capital requirements on the business cycle. Several approaches havebeen proposed to assess the procyclicality issue. In this paper, we adopt a generalequilibrium model and conduct comprehensive analysis of different proposals.We setout a model that allows to evaluate different rating systems in relation to the procyclicalityissue. Our model extends previous models by analysing the effects of differentrating systems on banks’ portfolios (as in Catarineu et al. in Econ Theory 26:537–557,2005) and the contagion effects relevant to financial stability (as in Goodhart et al. inAnn Finance 1:197–224, 2005). The paper presents comparative statics results comparinga cycle-dependent and a neutral rating system from the point of view of banksprofit maximization. Our results suggest that banks’ preferences about point in timeor through the cycle rating systems depend on the banks’ characteristics and on thebusiness cycle conditions in terms of expectations and realizations.