Bank Solvency and Funding Cost: New Data and New Results

By Stefan W. Schmitz, Michael Sigmund, Laura Valderrama

May 15, 2017

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Stefan W. Schmitz, Michael Sigmund, and Laura Valderrama. Bank Solvency and Funding Cost: New Data and New Results, (USA: International Monetary Fund, 2017) accessed September 19, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper presents new evidence on the empirical relationship between bank solvency and funding costs. Building on a newly constructed dataset drawing on supervisory data for 54 large banks from six advanced countries over 2004–2013, we use a simultaneous equation approach to estimate the contemporaneous interaction between solvency and liquidity. Our results show that liquidity and solvency interactions can be more material than suggested by the existing empirical literature. A 100 bps increase in regulatory capital ratios is associated with a decrease of bank funding costs of about 105 bps. A 100 bps increase in funding costs reduces regulatory capital buffers by 32 bps. We also find evidence of non-linear effects between solvency and funding costs. Understanding the impact of solvency on funding costs is particularly relevant for stress testing. Our analysis suggests that neglecting the dynamic features of the solvency-liquidity nexus in the 2014 EU-wide stress test could have led to a significant underestimation of the impact of stress on bank capital ratios.

Subject: Bank solvency, Banking, Capital adequacy requirements, Credit default swap, Financial regulation and supervision, Financial sector policy and analysis, Money, Solvency, Stress testing

Keywords: Asset volatility, Bank rating, Bank solvency, Capital adequacy requirements, Credit default swap, Feedback effect, Funding cost, Global, Liquidity risk bearing capacity, Net income, Nexus slashes bank, North America, Regulatory capital, Solvency, Solvency equation, Solvency risk, Stress testing, WP

Publication Details

Pages:

46
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2017/116
Stock No:

WPIEA2017116
ISBN:

9781484300664
ISSN:

1018-5941

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