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Interaction between credit risk, liquidity risk, and bank solvency performance: a panel study of Indian banks

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Abstract

Liquidity risk and credit risk are considered the two main sources of banking risk. This paper is an attempt to investigate their interconnectedness and impact on solvency performance banks. Using panel data of 42 public and private commercial banks in India over the period 2010–2019, we find that a bank’s liquidity as well as asset quality positions strongly influence its financial soundness (measured in terms of Z-solvency score). Further, bank size, capital positions, and income diversification are the significant drivers of a bank’s solvency performance. Our empirical results reveal that Basel 3 norms implementation by the Reserve Bank of India has strengthened the liquidity situation and the financial stability of Indian banks. We argue that it is essential for commercial banks to manage their credit risk and liquidity risk more proactively to remain financially solvent.

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Data availability

The authors confirm that the data that support the findings of this paper are collated from audited annual report of banks over years and from data source AceEquity.

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Acknowledgements

Authors gratefully acknowledge helpful comments and suggestions received from two anonymous reviewers to further improve this paper. We are thankful to the editor for invaluable suggestions during the revision process. All remaining errors are the author’s own.

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This research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors.

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Authors and Affiliations

  1. National Institute of Bank Management (NIBM), Pune, India

    Arindam Bandyopadhyay

  2. Accenture, Bengaluru, India

    Mayuri Saxena

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  1. Arindam Bandyopadhyay
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  2. Mayuri Saxena
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Correspondence to Arindam Bandyopadhyay.

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Bandyopadhyay, A., Saxena, M. Interaction between credit risk, liquidity risk, and bank solvency performance: a panel study of Indian banks. Ind. Econ. Rev. 58, 311–328 (2023). https://doi.org/10.1007/s41775-023-00202-y

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