Systemic Risk and the Solvency-Liquidity Nexus of Banks

Abstract

This paper highlights the empirical interaction between solvency and liquidity risks of banks that make them particularly vulnerable to an aggregate crisis. In line with the literature explaining bank runs based on the quality of the bank's fundamentals, I find that banks lose their access to short-term funding when markets expect they will be insolvent in a crisis. This solvency-liquidity nexus is found to be strong under many robustness checks and to contain useful information for forecasting the short-term balance sheet of banks. The results suggest that capital not only acts as a loss-absorbing buffer, but it also ensures the confidence of creditors to continue to provide funding to the banks in a crisis.

The interaction between bank solvency and funding costs: A crucial effect in stress tests

“…Within the second strand of the literature, Distinguin et al () and Pierret () study the endogenous relation between solvency and funding cost. Pierret () uses fixed effect panel vector autoregressive (PVAR) regressions to model the nexus between solvency and liquidity risk of banks in a set of 49 US banks examined over 2000–2013. Solvency risk is measured by the expected capital shortfall SRISK and liquidity risk exposure is measured by short‐term debt ratio to total assets.…”

Long Term Solvency Position of Select Public Sector Banks: An Analysis

“…The long-term financial soundness of any business can be judged by its long-term creditors by testing its ability y to pay interest charges regularly and its ability to repay the principal as per schedule. Diane Pierret(2015).his study highlights the empirical interaction between solvency and liquidity risks of banks that make them particularly vulnerable to an aggregate crisis. I find that banks lose their access to shortterm funding when markets expect they will be insolvent in a crisis.…”

On the Efficiency of Solvency Optimizing Guaranteed Returns in the Insurance Sector

“…Barnhill and Schumacher, 2011), or associated with an other method, for example with the calculation of regulatory capital ratios (e. g. Pierret, 2015). Literature also mentions the concept of Value-at-Risk (VaR) as having become a standard risk measure used to evaluate exposure to risk in an institution.…”