Discussion Paper

No. 2017-53 | August 17, 2017
The impact of Basel III on money creation: a synthetic analysis

Abstract

Recent evidences provoke broad rethinking of the role of banks in money creation. The authors argue that apart from the reserve requirement, prudential regulations also play important roles in constraining the money supply. Specifically, they study three Basel III regulations and theoretically analyze their standalone and collective impacts. The authors find that 1) the money multiplier under Basel III is not constant but a decreasing function of the monetary base; 2) the determinants of the bank’s money creation capacity are regulation-specific; 3) the effective binding regulation and the corresponding money multiplier vary across different economic states and bank balance sheet conditions.

JEL Classification:

E51, G28, G18, E60

Assessment

  • Downloads: 255

Links

Cite As

Wanting Xiong and Yougui Wang (2017). The impact of Basel III on money creation: a synthetic analysis. Economics Discussion Papers, No 2017-53, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2017-53


Comments and Questions


Anonymous - Invited Reader Comment
August 24, 2017 - 08:51

My overall impression is that the paper touches upon a very important subject, which has international implications, such as Basel III and the impacts on money creation.
It is also based on appropriate theoretical concepts (i.e. endogenous theory of money creation) and methodologies (e.g. stock flow consistent model).
Its main ...[more]

... findings are also very interesting and coherent.When authors mention that the same policy action may have distinct consequences in different scenarios,they highlight the importance of path dependence in events. Therefore, when authors draw policy recommendations, they are aware that policy makers should not look for "one size fits all" policies. Instead, they should be cautions in choosing the most appropriate instrument for each circumstance.


Yougui Wang - The authors' response
August 31, 2017 - 14:23

Thank you very much for your valuable comments!
The main findings that you highlighted here indeed have important policy implications, which are closely related to monetary policy and banking regulations. These findings are drawn from the new perspective that banks are the creators of money. When banks make lending, they ...[more]

... create both loans and deposits at the same time. The bank’s ability to create money depends on its balance sheet structure and all the requirements it is subject to. With the attenuation of the reserve requirement as a policy tool and regulatory constraints in modern banking system, we emphasize on the increasingly important roles of prudential regulations in money creation. We hope that our results could contribute to the understandings of the non-linear response of the broad money supply to the shocks on the monetary base, and further the transitions of monetary transmission under prudential regulations.


Anonymous - Invited Reader Comment
September 27, 2017 - 10:53

First, the outline and the arrangement of the paper is well chosen. The introduction states and backs a well-known but still current critique on standard economic theory. It does this in a very accurate way, referencing on several studies as well as explaining the logic behind the arguments put forward ...[more]

... there.

The second section then smoothly introduces the topic and gives a nicely structured overview on the the banking sector, its most important state variables, indicators, and instruments. Thanks to this section the paper may be recommended even to colleagues which are not that familiar with the topic so far.

The same may be said about the model and its intentional simplifications. While the latter of course gives scope for criticism with regard to empirical validity and especially applicability, it may as allows to keep focus and may serve as teaching material in introductory courses. However, to be consistent with this easy-to-read approach, in this chapter I would suggest a first specific amendment: Equation (23) should built on (5) to (8) and maybe that should be stated as it often is for other equations.

The same I would suggest for several equations given in the next section on the (theoretical) impacts of the Basel III regulations. It was not always that easy to collect the underlying assumptions in mathematical form and a critical reader will be thankful, if they are given for such crucial mathematical statements – e.g. equation (37), or equation (28) where I was not even able to reconstruct the “0.25”. If there is not enough scope for such additions yet, I suggest to think about the necessity of the passage on the exemplary 100% minimum LCR. I do not see that much value added by those equations (44) and (45).

Also in favour of the easy-to-read-and-follow apprach the sections on the model as well as the (theoretical) impacts of the regulations, it sometimes would be helpful to remind the reader of the model’s interpretation of monetary base, broad money supply and similar state variables whose definition may differ in other models on the same topic. Anyways, overall I consider the paper as a valuable contribution with regard to a theoretical discussion of banking regulations and the simplified model serves well for this purpose. To conclude with a minor remark: I am not sure, whether the title could be misleading – the prominent name of Basel III could raise expectations for an empirical analysis or at least a model applied on empirical data.


Anonymous - The authors' responses to the comments
November 19, 2017 - 15:08

Please see the uploaded PDF file for our responses.


Anonymous - Referee Report 1
November 09, 2017 - 10:32

Referee report on:
“The impact of Basel III on money creation: a synthetic analysis”
(Economics-2285-1)

SUMMARY
The paper develops a model that investigates the impact of the Basel III regulation on the money creation process and provided a comprehensive analysis for the three pillar regulations in the ...[more]

... Basel accord, including not only the enhanced risk-based capital adequacy regulation but also the requirements on the leverage ratio and the liquidity coverage ratio. Moreover, using both graphical illustration and a dynamic stock-flow consistent model, the authors elaborated on the central roles of commercial banks in money creation and the mechanism through which prudential regulations affect bank lending and money supply.

The main findings of the paper are:
- the money multiplier is a decreasing function of the monetary base under all three prudential regulations;
- the determinants of the banking system’s capacity of money creation are regulation-specific, due to the differences in the mechanisms through which different prudential regulations take effect;
- when the authors considered the simultaneous imposition of all three regulations, the bank’s capacity of money creation is binded by the most rigid constraint, the money multiplier under the collective influences of multiple regulations is obtained as the minimum value of the multipliers under each individual regulation, given the same monetary base and other things equal.


COMMENTS
The paper tackles with a very interesting issue. However, I have some minor suggestion:
• Stylized facts: To improve the motivation of the paper could be interesting add some evidence of the change in money creation after the introduction of the new Basel regulations.
• Model: the reasons behind the equation (27) is not clear to me. Could you better explain that and show what happen if you change this assumption. More in general, I think that the model needs some robustness check. The author should relax some assumption and show the results.
• Table 2: The Table 2 is useful to summarize the results in the first part of the model. The author can try to discuss more and compare the results.
• Figure 3: The results in Figure 3 are similar when we change the values used for rLCR rCAR and rLR
• Li et al. (2017): As the paper seems to be an extension of the model in Li et al. (2017), the authors should better explain the novelty of this paper respect to the other.
Minor comment:
In the references, there are some typos. For example, the first line starts with (2004), or for same paper, the author leave the expression et al. (e.g., Botos et al., 2016)


Anonymous - The authors' responses to the comments
November 23, 2017 - 16:45

Please see the uploaded file for our response and the revisions.


Anonymous - Referee Report 2
November 22, 2017 - 08:06

see attached file