To fail or not to fail? Disentangling capital and liquidity effects on US banks default

Pierre Durand, Gaëtan Le Quang () and Arnold Vialfont
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Pierre Durand: UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12, ERUDITE - Equipe de Recherche sur l’Utilisation des Données Individuelles en lien avec la Théorie Economique - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12 - Université Gustave Eiffel
Gaëtan Le Quang: UPN - Université Paris Nanterre, EconomiX - EconomiX - UPN - Université Paris Nanterre - CNRS - Centre National de la Recherche Scientifique
Arnold Vialfont: UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12, ERUDITE - Equipe de Recherche sur l’Utilisation des Données Individuelles en lien avec la Théorie Economique - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12 - Université Gustave Eiffel

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Abstract: Using a database comprising US bank balance sheet variables and the list of failed banks as provided by the FDIC, we run various models to compute banks' default probability in order to assess the impact of capital and liquidity on it. A companion website is available to execute the associated code on a Github repository. We provide evidence that 1) capital is a stronger predictor of default than liquidity, 2) Basel III capital requirements should be set at a higher level. Having a look at the impact of the interaction between capital and liquidity on the probability of default, we indeed show that the influence of the former completely outweighs that of the latter. Concerning the impact of capital ratios on the probability of default, we provide evidence that increasing the former allows reducing the latter up to a certain point. More precisely, it seems that when the risk-weighted ratio is around 15% and the simple leverage ratio around 10%, the probability of default reaches it lowest value. These results therefore call for strengthening capital requirements while at the same time releasing the regulatory pressure put on liquidity, especially for small banks.

Date: 2026-08-03
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Published in Applied Economics, inPress, pp.1-16. ⟨10.1080/00036846.2026.2669656⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05649575

DOI: 10.1080/00036846.2026.2669656

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