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Bank solvency risk and funding cost interactions in a small open economy: evidence from Korea

Iñaki Aldasoro and Kyounghoon Park ()

No 738, BIS Working Papers from Bank for International Settlements

Abstract: Using proprietary balance sheet data for Korean banks and a simultaneous equation model, we document that increased marginal funding costs lead to larger solvency risk (as measured by the Tier 1 regulatory capital ratio), which, in turn, leads to larger marginal funding costs. A 100 bp increase in marginal funding costs (solvency risk) is associated with a 155 (77) bp increase in solvency risk (marginal funding costs). The findings of an economically and statistically significant relationship are robust to considering different proxies for solvency risk, types of banks, interest rate regimes, and interest margin management strategies. They also hold irrespective of the funding profile considered. FX-related macroprudential policies can affect the negative feedback loop by muting the effect of marginal funding costs on solvency risk. Our findings can inform the calibration of macroprudential stress tests.

Keywords: solvency risk; funding cost; simultaneous equation model; stress testing; macroprudential policy; bank business models (search for similar items in EconPapers)
JEL-codes: C50 G00 G10 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mac
Date: 2018-08
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