Conclusion

Starting from the observation that most banks hold more capital than the re-quired minimum and moreover to varying extents we have set up a model of a banking system in which we can analyse the e¤ect of a change in aggregate risk, like in an upswing or in a downswing, on aggregate credit supply to …rms. We

…nd that the extent to which aggregate bank credit ‡uctuates with or without a capital constraint depends crucially on the ease with which additional assets like funds from the interbank market can be added to or withdrawn from the aggregate balance sheet of the banking sector, which is re‡ected in the sensitiv-ity of the interbank rate with respect to a change in aggregate risk. In addition,

the introduction of a bank capital constraint changes the equilibrium interbank rate, the marginal responses of bank lending to a change in risk and the propor-tions of interbank borrowers and lenders. Therefore the e¤ect of introducing a bank capital constraint with constant or with variable risk-weights a¤ects not only the behaviour of constrained but also the one of the unconstrained banks.

Consequently, the cyclicality of aggregate credit is a function of the sensitivity of risk-weights with respect to changes in risk, the responses of lending by con-strained and by unconcon-strained banks in the system, their respective shares in the banking sector and the sensitivity of the interbank rate with regard to a change in aggregate risk.

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