Pierret, Diane
[NYU Stern School of Business]
This paper 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 short-term funding when markets expect they will be insolvent in a crisis. Conversely, the expected amount of capital a bank should raise to remain solvent in a crisis (its capital shortfall) increases when the bank holds more short-term debt (has a larger exposure to funding liquidity risk). 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 the solvency-liquidity interaction should be accounted for when designing liquidity and capital requirements, in contrast to Basel III regulation where solvency and liquidity risks are treated separately.
Bibliographic reference |
Pierret, Diane. Systemic risk and the solvency-liquidity nexus of banks. CORE Discussion Paper ; 2014/38 (2014) |
Permanent URL |
http://hdl.handle.net/2078.1/152299 |