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The interaction between bank solvency and funding costs: A crucial effect in stress tests
Author(s) -
Schmitz Stefan W.,
Sigmund Michael,
Valderrama Laura
Publication year - 2019
Publication title -
economic notes
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.274
H-Index - 19
eISSN - 1468-0300
pISSN - 0391-5026
DOI - 10.1111/ecno.12130
Subject(s) - solvency , nexus (standard) , stress test , panel data , economics , capital (architecture) , estimation , capital requirement , solvency ratio , actuarial science , test (biology) , monetary economics , business , econometrics , finance , computer science , microeconomics , management , archaeology , incentive , market liquidity , history , embedded system , paleontology , biology
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.