Bank Solvency Risk and Funding Cost Interactions in a Small Open Economy: Evidence from Korea

54 Pages Posted: 23 Aug 2018

See all articles by Iñaki Aldasoro

Iñaki Aldasoro

Bank for International Settlements (BIS)

Kyounghoon Park

The Bank of Korea

Date Written: August 1, 2018

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

JEL Classification: C50, G00, G10, G2

Suggested Citation

Aldasoro, Iñaki and Park, Kyounghoon, Bank Solvency Risk and Funding Cost Interactions in a Small Open Economy: Evidence from Korea (August 1, 2018). BIS Working Paper No. 738, Available at SSRN: https://ssrn.com/abstract=3236932

Iñaki Aldasoro (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Kyounghoon Park

The Bank of Korea ( email )

39, Namdaemun-ro, Jung-gu
Seoul, 04531
Korea, Republic of (South Korea)

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