The Pro‐Cyclical Impact of Basel II on Emerging Markets and its Political Economy

Abstract

This chapter stresses the importance of banking regulations — and of a well functioning banking system — for economic growth. It examines both positive and problematic features of Basel II, the new international banking regulation. The concerns include the overestimation of risk of international bank lending to developing countries, as clear benefits of international diversification are not included. This creates a risk that international bank lending to developing countries could be sharply reduced and remaining lending could see its cost increased. The second concern is that it would accentuate the pro-cyclicality of bank lending, damaging all economies, but especially the more fragile developing ones. The chapter concludes with concrete policy proposals which could avoid these negative effects, such as introducing diversification benefits into Basle II and encouraging forward-looking provisioning to counter-act pro-cyclical effects.

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