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The solvency and funding cost nexus - the role of market stigma for buffer usability

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  • Helena Carvalho

Abstract

In this paper, we investigate the relationship between the banks’ solvency ratio and their funding costs using a proprietary dataset from Banco de Portugal for 21 Portuguese banks from 2006 to 2020. In light of the discussion on impediments to capital buffer usability by banks, we focus on the importance of market discipline to this relationship. Our results suggest that the relationship between solvency and funding costs is negative and state-dependent, i.e. market participants become more sensitive to changes in solvency during economic downturns. The relationship is stronger for market-based financing sources in comparison to deposits. Finally, we use a breakpoint analysis and find that investors are more likely to penalize the same absolute deterioration in solvency levels when banks are already in a fragile position. Our findings support the hypothesis that fear of market stigma may make banks reticent to use buffers in times of stress.

Suggested Citation

  • Helena Carvalho, 2022. "The solvency and funding cost nexus - the role of market stigma for buffer usability," Working Papers w202211, Banco de Portugal, Economics and Research Department.
    • Handle: RePEc:ptu:wpaper:w202211
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    References listed on IDEAS

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    1. Miss Rita Babihuga & Marco Spaltro, 2014. "Bank Funding Costs for International Banks," IMF Working Papers 2014/071, International Monetary Fund.
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    3. Aldasoro, Iñaki & Cho, Chun Hee & Park, Kyounghoon, 2022. "Bank solvency risk and funding cost interactions: Evidence from Korea," Journal of Banking & Finance, Elsevier, vol. 134(C).
    4. Thomas B. King, 2008. "Discipline and Liquidity in the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(2‐3), pages 295-317, March.
    5. Elyas Elyasiani & Jason Keegan, 2017. "Market Discipline in the Secondary Bond Market: The Case of Systemically Important Banks," Working Papers 17-5, Federal Reserve Bank of Philadelphia.
    6. Couaillier, Cyril & Lo Duca, Marco & Reghezza, Alessio & Rodriguez d’Acri, Costanza & Scopelliti, Alessandro, 2021. "Bank capital buffers and lending in the euro area during the pandemic," Financial Stability Review, European Central Bank, vol. 2.
    7. Isaiah Andrews & James H. Stock & Liyang Sun, 2019. "Weak Instruments in Instrumental Variables Regression: Theory and Practice," Annual Review of Economics, Annual Reviews, vol. 11(1), pages 727-753, August.
    8. Mr. Stefan W. Schmitz & Michael Sigmund & Ms. Laura Valderrama, 2017. "Bank Solvency and Funding Cost: New Data and New Results," IMF Working Papers 2017/116, International Monetary Fund.
    9. Demirguc-Kunt, Asli & Huizinga, Harry, 2004. "Market discipline and deposit insurance," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 375-399, March.
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    Cited by:

    1. Lucas Avezum, 2023. "To use or not to use? Capital buffers and lending during a crisis," Working Papers w202308, Banco de Portugal, Economics and Research Department.

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    More about this item

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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