The Relationship between Liquidity Risk and Credit Risk in Banks

Björn Imbierowicz, Christian Rauch

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

This paper investigates the relationship between the two major sources of bank default risk: liquidity risk and credit risk. We use a sample of virtually all U.S. commercial banks during the period 1998 to 2010 to analyze the relationship between these two risk sources on the bank institutional-level and how this relationship influences banks’ probabilities of default (PD). Our results show that both risk categories do not have an economically meaningful reciprocal contemporaneous or time-lagged relationship. However, they do influence banks’ probability of default. This effect is twofold: whereas both risks separately increase the PD, the influence of their interaction depends on the overall level of bank risk and can either aggravate or mitigate default risk. These results provide new insights into the understanding of bank risk and serve as an underpinning for recent regulatory efforts aimed at strengthening banks (joint) risk management of liquidity and credit risks.
Original languageEnglish
JournalJournal of Banking & Finance
Volume40
Pages (from-to)242–256
ISSN0378-4266
DOIs
Publication statusPublished - Mar 2014
Externally publishedYes

Keywords

  • Liquidity risk
  • Credit risk
  • Bank risk
  • Bank default probability

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