Solvency
Solvency refers to a bank’s ability to meet its long-term financial obligations and absorb losses.
Meaning in Practice
In practice, solvency depends on the adequacy of a bank’s capital relative to its risk-weighted assets. Regulatory capital ratios, such as CET1 and Tier 1 capital, measure solvency strength. A solvent bank maintains sufficient buffers to withstand unexpected losses.
Why It Matters
Solvency is fundamental to financial system stability and depositor confidence. Insolvent institutions may require restructuring, resolution, or recapitalization. Strong solvency positions reduce systemic risk.
Market Impact
Concerns about solvency can lead to falling bank equity prices and rising funding costs. Investors closely monitor capital ratios during periods of economic stress. Persistent solvency issues can trigger broader market contagion.
Example
If a bank suffers large loan losses that exceed its capital base, it may become insolvent and require regulatory intervention.