Discussion Paper Details

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Title: Bank Capital Redux: Solvency, Liquidity, and Crisis

Author(s): Ďscar JordÓ, Bj÷rn Richter, Moritz Schularick and Alan M. Taylor

Publication Date: March 2017

Keyword(s): bank liabilities, capital ratio, crisis prediction, Financial crises and local projections

Programme Area(s): Economic History, Financial Economics and Monetary Economics and Fluctuations

Abstract: Higher capital ratios are unlikely to prevent a financial crisis. This is empirically true both for the entire history of advanced economies between 1870 and 2013 and for the post-WW2 period, and holds both within and between countries. We reach this startling conclusion using newly collected data on the liability side of banks' balance sheets in 17 countries. A solvency indicator, the capital ratio has no value as a crisis predictor; but we find that liquidity indicators such as the loan-to-deposit ratio and the share of non-deposit funding do signal financial fragility, although they add little predictive power relative to that of credit growth on the asset side of the balance sheet. However, higher capital buffers have social benefits in terms of macro-stability: recoveries from financial crisis recessions are much quicker with higher bank capital.

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Bibliographic Reference

JordÓ, Ď, Richter, B, Schularick, M and Taylor, A. 2017. 'Bank Capital Redux: Solvency, Liquidity, and Crisis'. London, Centre for Economic Policy Research.