Assessment of the output floor in an agent-based credit network model

Abstract

This paper evaluates the effectiveness of the output floor, a key component of the Basel III finalization within an agent-based credit network model encompassing both corporate and interbank loan markets with heterogeneous firms and banks. The model is designed to replicate the evolution of key financial indicators in the Euro Area and is calibrated to empirical output floor settings. The findings confirm that the output floor is a crucial tool for enhancing banking regulation efficiency. It raises the average and reduces the dispersion of risk-weighted asset (RWA) density (i.e., the RWA-to-total assets ratio) across banks. Additionally, it improves alignment between the RWA densities of banks using the internal ratings-based and standardized approaches, thereby strengthening financial actors’ confidence in banking regulation. However, accommodative monetary policy fosters risk accumulation in the banking sector, undermining the output floor’s effectiveness, while tighter monetary policy has the opposite effect. Consequently, financial regulators must carefully coordinate policies to ensure banking stability.