Non-core Liabilities, Liquidity Channels and Banks' Systemic Risks:Theoretical Models and Empirical Analysis
FANG Yi, HE Wenjia, WANG Qi
National School of Development and Strategy, Renmin University of China; School of Economics, Beijing Technology and Business University; School of Finance, Central University of Finance and Economics
Summary:
The interbank businesses of commercial banks serve as a crucial mechanism for managing short-term liquidity, adjusting fund surpluses and shortages, and optimizing resource allocation. However, these operations also entail various risks such as regulatory arbitrage, maturity mismatch, funds idling, and shadow banking. In recent years, it is not uncommon for domestic and foreign financial institutions to almost cause systemic risks due to the rapid growth of interbank businesses. For instance, in March 2023, Silicon Valley Bank and Signature Bank in the United States experienced consecutive crises due to liquidity problems stemming from unstable funding sources. According to the historical data from China's banking industry, the scale of non-core liabilities of deposit-taking financial companies increased from 1.66 trillion yuan to 13.95 trillion yuan from 2007 to 2016, while their proportion doubled during this period. Although deleveraging policies have reduced the proportion of interbank liabilities since 2017, its absolute scale remains high. The potential risk associated with excessive reliance on interbank liabilities of banks should not be underestimated.Interbank liabilities are classified as non-core liabilities, which possess inherent instability that can easily trigger liquidity risks on both the asset and liability sides of banks and liquidity risk is a significant contributor to systemic risk. In November 2023, the “Measures for the Capital Management of Commercial Banks” issued by China's General Administration of Financial Supervision increased the risk measurement weight assigned to interbank business, highlighting regulatory authorities' ongoing focus on preventing systemic risks associated with non-core liabilities.Starting from the perspective of non-core liabilities of banks, this paper discusses the theoretical mechanism and empirical evidence regarding the impact of non-core liabilities on banks' systemic risks through liquidity channels and draws the following conclusions. Firstly, banks relying on non-core liabilities financing to invest in illiquid assets will bring systemic risks, with larger banks experiencing a greater impact of non-core liabilities on their systemic risks. This paper replaces core explanatory variables and explained variables, changes the estimation method, considers risk events during the sample period, expands the sample based on KNN machine learning and news text sentiment data, and addresses endogeneity problems using heteroscedasticity-based instruments, Bartik instrumental variables, and Heckman two-stage model. The fundamental conclusion that non-core liabilities increase banks' systemic risk remains valid. Secondly, bank asset liquidity and liability liquidity serve as important mechanisms through which non-core liabilities affect systemic risks. The liquidity of bank is reflected in the discount rate applied to illiquid assets sold in advance; higher discount rates indicate greater asset liquidity risk. Liability liquidity is reflected in the unextended ratio of non-core liabilities; higher ratios imply increased liability liquidity risk. When faced with high levels of liquidity risk there is an enhanced positive impact of non-core liabilities on systemic risk due to excessive holdings of such debt by banks which exposes them to potential delays or failure in rolling over these obligations timely. In such scenarios where liability liquidity risk increases significantly, banks need to divest more illiquid assets for repaying non-core liabilities that have not yet been extended yet. If there is also a rise in asset liquidity risk during this period, it results in heightened capital losses for banks, thereby amplifying overall levels of systemic risk.Based on the aforementioned research findings, this paper proposes that banks and regulatory authorities should actively monitor the scale and growth rate of non-core liabilities of banks and put forward stricter non-core liabilities management requirements for larger banks, so as to proactively prevent the risk accumulation resulting from the expansion of illiquid assets relying on non-core liabilities, thereby effectively averting systemic risks in the banking sector. In terms of bank liquidity risk management, counter-cyclical preventive policies should be adopted. When the scale of non-core liabilities expands excessively fast, restrictions can tighten the overall bank liquidity, limit the growth of non-core liabilities, and then reduce bank's risk accumulation. When the banking systemic risks increase, it is appropriate to relax bank liquidity in order to minimize the capital loss caused by the decline in liquidity and effectively alleviate the systemic risk.
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