Bank solvency: The role of credit and liquidity risks, regulatory capital and economic stability

  • Received June 7, 2021;
    Accepted September 20, 2021;
    Published November 22, 2021
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  • Article Info
    Volume 16 2021 , Issue #4, pp. 84-100
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    1 articles

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This work is licensed under a Creative Commons Attribution 4.0 International License

Banking stability is essential to any economy due to its many functions, including intermediation, payment facilitation, and credit creation. Thus, the stability of the banking industry is one of the critical ingredients in economic growth. This paper analyzes how bank capital requirements, credit, and liquidity impact bank solvency using ten major banks that control 90% of the market share in the UK in 2009–2018.
The GMM model indicates a strong association between credit and liquidity risks. That is, when banks finance a risky or distressed project, this will lead to an increase in non-performing loans (NPL), which reduces bank liquidity. Poor liquidity profile of the bank may restrict it from providing financial intermediation role. In addition, the findings indicate that efficiency, asset quality, and economic growth have a significant positive effect on the solvency of banks. The results also show that the regulatory capital (tier1) has a positive significant influence on solvency of the banks. Further, the results indicate that during the economic boom, banks tend to increase their regulatory capital. Therefore, there is a need to ensure that during the “good time”, banks can accumulate enough capital that is genuinely capable of absorbing negative shock. Also, it is important for banks to ensure that they are efficient but also have robust credit appraisal system to reduce NPL. This paper also demonstrates the implication of increased capital requirements. That is, increased capital requirements ensure not only banks are liquid but also solvent which enables them to provide financial intermediation.

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    • Table 1. Measurement of variables
    • Table 2. Heteroskedasticity test: Breusch-Pagan-Godfrey
    • Table 3. Breusch-Godfrey serial correlation LM test
    • Table 4. Ramsey RESET test
    • Table 5. Summary statistics
    • Table 6. Correlation matrix
    • Table 7. Credit and liquidity risk models
    • Table 8. Determinants of the solvency ratio
    • Table A1. Panel unit root tests
    • Table A2. Overview of revised standardized risk-weighted bank assets
    • Table A3. Fixed effect model
    • Conceptualization
      Isaiah Oino
    • Data curation
      Isaiah Oino
    • Formal Analysis
      Isaiah Oino
    • Investigation
      Isaiah Oino
    • Methodology
      Isaiah Oino
    • Project administration
      Isaiah Oino
    • Software
      Isaiah Oino
    • Writing – original draft
      Isaiah Oino
    • Writing – review & editing
      Isaiah Oino