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

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  • Iñaki Aldasoro
  • Kyounghoon Park

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.

Suggested Citation

  • Iñaki Aldasoro & Kyounghoon Park, 2018. "Bank solvency risk and funding cost interactions in a small open economy: evidence from Korea," BIS Working Papers 738, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:738
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    More about this item

    Keywords

    solvency risk; funding cost; simultaneous equation model; stress testing; macroprudential policy; bank business models;
    All these keywords.

    JEL classification:

    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • G00 - Financial Economics - - General - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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