Output floor curbs mortgage lending and stabilises bank assets

Using an estimated DSGE model calibrated on UK data from 1991 to 2019, the researchers evaluate the macroeconomic effects of capping internal models at 72.5 percent of the standardised approach.

Under a positive productivity shock, the output floor binds because modelled risk weights decline during economic upswings.

The framework uncovers pronounced sectoral reallocation: mortgage risk weights average 53 percent of standardised levels, compared to 81 percent for corporate exposures.

Consequently, the binding floor increases the marginal capital cost of mortgages while lowering the relative cost of corporate loans.

This dynamic dampens household credit growth while corporate lending expands, driving higher investment in productive capital assets.

The Basel Committee introduced the output floor in its post-crisis finalisation package to counter excessive variance and cyclicality in internal risk models.

In the UK, the Prudential Regulation Authority scheduled implementation to start in January 2027 at a 60 percent threshold, rising gradually to the full 72.5 percent requirement by January 2030.

The authors show that the rule lowers the volatility of the credit-to-GDP ratio by 12 percent under technology shocks and reduces the macroprudential authority's loss function by up to 23 percent.