The Interaction between Bank Solvency and Funding Costs: A Crucial Effect in Stress Tests

31 Pages Posted: 14 May 2020

See all articles by Stefan W. Schmitz

Stefan W. Schmitz

Oesterreichische Nationalbank (OeNB); Vienna Circle Society

Michael Sigmund

Oesterreichische Nationalbank (OeNB)

Laura Valderrama

International Monetary Fund - Monetary and Capital Markets Department

Date Written: July 2019

Abstract

This paper presents new evidence on the empirical relationship between bank solvency and funding costs. Building on a newly constructed data set drawing on the supervisory data of 54 large banks from six advanced countries over 2004–2013, we use a simultaneous equation approach with panel data to estimate the contemporaneous interaction between solvency and funding costs. Our results and test statistics show that these two are (a) determined simultaneously and (b) more pronounced 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 113 bps. A 100‐bps increase in funding costs reduces regulatory capital buffers by 48 bps. Applying our estimation results to the 2014 EU‐wide stress test reveals that neglecting the solvency‐funding cost nexus leads to the systematical and significant underestimation of the impact of shocks on bank capital ratios.

Suggested Citation

Schmitz, Stefan W. and Sigmund, Michael and Valderrama, Laura, The Interaction between Bank Solvency and Funding Costs: A Crucial Effect in Stress Tests (July 2019). Economic Notes, Vol. 48, Issue 2, pp. n/a-n/a, 2019, Available at SSRN: https://ssrn.com/abstract=3597064 or http://dx.doi.org/10.1111/ecno.12130

Stefan W. Schmitz (Contact Author)

Oesterreichische Nationalbank (OeNB) ( email )

Otto-Wagner Platz 3
POB 61
Vienna 1011
Austria

Vienna Circle Society ( email )

Spitalgasse 2-4, Court 1
Vienna, 1090
Austria

Michael Sigmund

Oesterreichische Nationalbank (OeNB) ( email )

Otto-Wagner-Platz 3, PO Box 61
Vienna,
1010 Vienna, A-1011
Austria

Laura Valderrama

International Monetary Fund - Monetary and Capital Markets Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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