Financial globalisation and financial innovation have increased most banks’ appetite for risk and therefore engendered financial fragility in the financial system. This paper examines the relationship between regulatory bank capital adequacy and the business cycle in South Africa using Vector error correction model (VECM). This paper employed quarterly data from South Africa Reserve Bank (SARB) for the period 1990 to 2013. The Johansen Cointegration approach was used to ascertain whether there is indeed a long-run co-movement between capital adequacy and the business cycle. Results from the tests and VECM model show that there are significant linkages among the variables, especially between capital adequacy and the business cycle. The impulse analysis result shows that the response of the business cycle to one standard deviation shock of capital adequacy is negative and persistent for over 25 quarters before stabilizing. This shows the procyclicality effect of the business cycle. In other words, the imposition of a capital adequacy requirement can amplify the business cycle in South Africa. The result shows that fluctuation in the business cycle can be amplified by the bank capital adequacy requirements in South Africa.
Can bank capital adequacy changes amplify the business cycle in South Africa?
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