Abstract

The main purpose of this paper is twofold First it aims to estimate the effect of the tightening of regulatory capital requirements on the real economy during credit upswing Second it intends to show whether applying a countercyclical capital buffer measure as per the Basel III rules could have helped decelerate FX lending growth in Hungary mitigating the build-up of vulnerabilities in the run-up to the global financial crisis To answer these questions we use a Vector Autoregression-based approach to understand how shocks affected to capital adequacy in the pre-crisis period Our results suggest that regulatory authorities could have slowed the increase in lending temporarily They would not however have been able to avoid the upswing in FX lending by requiring countercyclical capital buffers even if such a tool had been available and they had reacted quickly to accelerating credit growth Our results also suggest that a more pronounced tightening might have reduced FX lending substantially but at the expense of real GDP growth The reason is that an unsustainable fiscal policy led to a trade-off between economic growth and the build-up of new vulnerabilities in the form of FX lending