Simualtion Banco

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QUAECO-1235; No. of Pages 24 ARTICLE IN PRESS

The Quarterly Review of Economics and Finance xxx (2020) xxx–xxx
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The Quarterly Review of Economics and Finance

journal homepage: www.elsevier.com/locate/qref
The impact of the Basel III liquidity ratios on banks:

Evidence from a simulation study夽
Peter Grundke ∗ , André Kühn
Osnabrueck University, Chair of Banking and Finance, Katharinenstraße 7, 49074 Osnabrueck, Germany
a r t i c l e i n f o a b s t r a c t
Article history: We construct a bottom-up simulation model that draws on a bank’s stylized disaggregated balance sheet
Received 26 May 2017 to measure the impact of both LCR and NSFR. The constructed balance sheet comprises fixed-income
Received in revised form 25 January 2019 items, stocks, deposits, and off-balance sheet items. The simulation model accounts for credit risk, interest
Accepted 24 February 2019
rate risk, and liquidity risk including their interactions. Regarding bank liquidity risk, the model accounts
Available online xxx
for withdrawal risk in non-maturing deposits, the call-off risk of irrevocably committed credit lines and
market price risk of assets. Our main results are summarized as follows: First, the introduction of LCR
JEL classification:
and NSFR has no unambiguous impact on bank’s equity return and balance sheet growth. Second, the
G21
G28
introduction of the liquidity ratios helps to reduce default risk. Third, it is more difficult for banks to
G32 comply with the ratios’ thresholds in macroeconomic stress scenarios than in other scenarios. Fourth,
the reduction of maturity transformation can effectively close liquidity gaps within one year. However,
Keywords: this comes at the cost of a higher frequency of future negative net cash flows above one year.
Basel III © 2019 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.
Bottom-up approach
Economic capital
Integrated risk measurement
LCR
Liquidity risk
NSFR
1. Introduction NSFR aims at ensuring the banks’ long-term liquidity. This measure
is based on a 1-year scenario horizon and requires banks to finance
Since the financial turmoil 2007–2009, both financial authori- long-term assets by long-term liabilities.
ties and banks have been reacting to the events during this crisis As these measures influence the bank’s asset and liability alloca-
by implementing stricter liquidity risk management practices. The tion, they might easily influence bank performance.1 In this paper,
two probably most important quantitative liquidity measures that we investigate the liquidity ratios’ impact on four measures of bank
have been introduced are the liquidity coverage ratio (LCR) and the performance. First, as increasing the proportion of high quality
net stable funding ratio (NSFR). The measures act complementary and liquid assets and reducing the maturity transformation might
and aim at promoting banks’ ability to meet their obligations. The lead to decreasing net incomes, we explore the ratios’ impact on
LCR addresses the bank’s short-term liquidity. It compels banks to bank equity return. As the equity base of a bank influences its
hold enough high quality and liquid assets (HQLA) to cover their ability to roll-over liabilities, there should secondly also be a rela-
net cash outflows within a 30-days stress scenario. In contrast, the tion between the liquidity ratios and balance sheet growth. Third,
since the ratios aim at lowering the illiquidity probability of a
bank, we also assess whether both ratios accomplish their intended
夽 This paper summarizes the results of the PhD thesis of Ruwisch (2018) which is
goals. The fourth and last aspect under consideration relates to a
based on a joint project of Peter Grundke and André Ruwisch (married Kühn). We
bank’s future cash flows because both ratios influence a bank’s net
thank the anonymous reviewer for helpful comments. We thank the Deutsche Bun- cash flows. For example, due to NSFR-induced limits of the bank’s
desbank for providing comprehensive bank balance sheet data and Thilo Pausch and maturity transformation, lower net outflows from lower maturity
Kamil Pliszka for providing kindly support during the project. Also, we would like
to thank Florian Kaposty for kindly providing regression parameters on depositors’
behavior in the German banking sectors.
∗ Corresponding author.
1
E-mail addresses: peter.grundke@uni-osnabrueck.de (P. Grundke), For a theoretical foundation of the impact of liquidity measures on banks see,
aruwisch@uni-osnabrueck.de (A. Kühn). e.g., Farhi, Golosov, and Tsyvinski (2009) and Walther (2015).
https://doi.org/10.1016/j.qref.2019.02.005
1062-9769/© 2019 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.
Please cite this article in press as: Grundke, P., & Kühn, A. The impact of the Basel III liquidity ratios on banks: Evidence from a simulation
study. The Quarterly Review of Economics and Finance (2020), https://doi.org/10.1016/j.qref.2019.02.005
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2 P. Grundke, A. Kühn / The Quarterly Review of Economics and Finance xxx (2020) xxx–xxx
buckets can be expected when a bank needs to increase the average these factors can be interpreted as run-off factors in a 30-days stress
maturity of its liabilities. scenario. They depend for example on the type of creditor (private,
We investigate the above mentioned objectives by using a com- large corporate, financial) or the assumed stability of deposits.
prehensive balance sheet simulation model. This approach has Moreover, the cash flows from HQLA must not be captured in
several advantages. First, it allows to directly measure the com- the denominator to avoid double counting. Besides that, the BCBS
bined impact of the Basel III calibration of both liquidity ratios. This included a lower bound for the amount of HQLA each bank needs
would not be possible in a regression approach because the NSFR to hold to comply with the LCR-requirement. As can be seen from
is still not fully in place yet. Besides, the length of available time Eq. (1), this lower bound is 25% of the stressed outflows in the 30-
series (with respect to the influence of the LCR) would be rather days period.
short. Moreover, a simulation enables us to investigate the impact The NSFR complements the LCR by requiring banks to finance
of LCR and NSFR in a controlled environment. Thus, the simulated their long-term assets (required stable funding, RSF) by long-term
bank’s behavior will not be influenced by other regulatory shocks, liabilities (available stable funding, ASF)
e.g. the introduction of other regulatory requirements.
ASF
Our results show that the introduction of both liquidity ratios NSFR = ≥ 1. (2)
RSF
has no unambiguous impact on neither bank equity growth nor
balance sheet growth. While this result might be surprising, it can This instrument aims to limit a bank’s maturity transformation.
be traced back to offsetting effects between net interest income The BCBS defined detailed weighting factors that determine to what
and credit risk losses. Net interest income decreases with the extent a specific asset or liability class is considered as stable.3 As
implementation of the liquidity ratios as banks invest more in this instrument aims at a time horizon of 1 year, all assets and lia-
high quality assets and assets with shorter maturities, respec- bilities with a residual maturity above 1 year receive a weighting
tively. At the same time, credit risk losses decrease as high quality of 100%. In contrast, assets and liabilities with a residual matu-
assets default less often. Moreover, investing in shorter maturities rity below this threshold receive lower weightings in general. The
requires banks to reinvest at a higher frequency. This, however, smaller an ASF-factor, the smaller is the assumed stability of a liabil-
enables them to prevent their credit portfolio quality from dete- ity in a 1- year stress scenario. The ASF-factors depend for example
riorating as long as enough high quality investment options exist. on the type of creditor (private, small corporate, large corporate,
This also helps to reduce defaults and their associated losses. Our financials). The RSF-factor of an asset is larger, the less likely it is
results also indicate that the introduction of LCR and NSFR on aver- that this asset can be liquidated (or used as collateral) in a 1-year
age reduces bank’s default probabilities. By separating between stress scenario, hence, the more likely it is that this asset needs a
equity-related and liquidity-related default risk, we also show that refinancing.
both types of default risk tend be reduced by the introduction of
the liquidity ratios. Lastly, the reduction of maturity transforma- 3. Literature review
tion can effectively close liquidity gaps within one year. However,
this comes at the cost of a higher frequency of future negative net This paper contributes to two strands of literature. On the one
cash flows above one year. hand, it contributes to the growing literature on bank balance sheet
The paper is organized as follows. Section 2 briefly summarizes simulation models. One well-known example is the comprehensive
the main characteristics of the Basel III liquidity ratios. Section 3 approach of Aikman et al. (2011). Their model captures different
reviews the related literature. The dynamic balance sheet model factors influencing the likelihood of bank default, accounts for con-
is outlined in Section 4. We parameterize the initial balance sheets tagion effects during default events, and is applied to a network of
and necessary parameters in Section 5. Section 6 presents the simu- large UK institutions. Wong and Hui (2011) also construct a bal-
lation results. In Section 7 we discuss the model risk inherent to our ance sheet simulation model with network interactions. However,
approach. We infer policy implications from our results and sketch the authors use different assumptions regarding the balance sheet
future research directions in Section 8. Finally, Section 9 concludes. structure of banks. For example, while Aikman et al. (2011) focus on
the banking book structure as given by accounting rules, Wong and
2. Summary of LCR and NSFR Hui (2011) treat all liabilities as non-maturing deposits. Further-
more, in contrast to Aikman et al. (2011), Wong and Hui (2011) also
The liquidity ratios LCR and NSFR have been proposed by the take off-balance sheet items into account, thereby capturing the
Basel Committee of Banking Supervision (BCBS) shortly after the liquidity-related default risk arising from these items. The authors
financial crises 2007–2009 to prevent banks from excessively tak- calibrate their model for Hong Kong banks.
ing liquidity risk. To do so, the LCR obliges banks to keep enough Both of the above mentioned models have in common that they
HQLA to cover their net cash outflows within a 30-days stress sce- exhibit a flexible simulation horizon. This means both models are
nario. In general, the LCR-requirement can be summarized as designed to simulate the balance sheets at arbitrary step sizes and at
HQLA any desired number of simulation steps. This is possible by specify-
LCR = ≥ 1. (1)
Cash outflows − min(0.75 · Cash out flows, Cash inflows) ing a sequence of events and actions mechanically repeating in each
Assets need to meet predefined qualitative criteria to qualify step. In contrast to this approach, Van den End (2012) constructs
as HQLA. In order to calculate the amount of HQLA, each eligible a model that is restricted to a fixed simulation horizon compris-
asset is weighted by a predefined factor. The smaller this factor, ing three distinct steps, whereby each one accounts for a different
the larger is the assumed loss of market value in the stress sce- event. The model relies on a reduced-form approach to network
nario. These factors depend for example on the type of the issuer effects and, hence, does not require a modeling of multiple balance
(sovereigns, corporates, financials) or the rating of the issuer. In sheets. Van den End (2012) applies his model to the Dutch banking
order to create a full stress scenario, the BCBS also predefined sev- sector. His model, in contrast to the approaches of Aikman et al.
eral weighting factors for the cash outflows resulting from liabilities (2011) and Wong and Hui (2011), also accounts for the impact of
and for cash inflows resulting from assets.2 In case of cash outflows, the LCR on banks. When capturing the LCR impact on banks, Van
2 3
See, e.g., BCBS (2013) for detailed information on factors of the HQLA and outflow See, e.g., BCBS (2014a) for detailed information on the ASF- and RSF-factors of
and inflow factors of the LCR. the NSFR.
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P. Grundke, A. Kühn / The Quarterly Review of Economics and Finance xxx (2020) xxx–xxx 3
den End (2012) simplifies the liquidity ratios’ calibration to a large 4.1. Valuation and stochastic evolution of items
extent. Moreover, the author uses stochastic weightings of the com-
ponents of the LCR instead of structural risk factors as drivers of the 4.1.1. Fixed-income items
bank simulation. Fixed-income items constitute the majority of bank balance
Barnhill and Schumacher (2014) construct a simple balance sheet items and comprise e.g. loans, drawn parts of committed
sheet simulation model with network interactions and two simula- credit facilities, bonds, etc. Within the model, the book value of
tion steps, whereby each step relates to another risk type. While the any fixed-income item held in the banking book equals its nomi-
first step relates to credit stress and illustrates its effect on equity- nal value, whereas the book value of any fixed-income item in the
related bank defaults, liquidity-related second round effects follow trading book equals its present value. Hence, valuation changes of
in the second step. Barnhill and Schumacher (2014) calibrate their trading book items have an instantaneous impact on the bank’s
model for the US banking sector. equity. The present value of a fixed-income item is computed by
On the other hand, this paper contributes to the strand of empir- discounting the item’s cash flows with the item’s specific risk-
ical literature investigating the impact of the LCR and NSFR on adjusted discount rate.
banks. Except for Van den End (2012), this literature is solely com- The cash flows of any fixed-income item are composed of its
posed of papers using regressions or descriptive statistics to assess principal amount and its coupon payments. Following Drehmann,
the impact of the liquidity ratios. Due to data restrictions, this lit- Sorensen, and Stringa (2010), the coupon rates are determined
erature approximates the impact of the Basel III liquidity ratios in such a way that all bonds are par-yield bonds at their time of
by investigating the impact of earlier national regulatory liquidity issuance.4 This approach allows us model both, constant and vari-
requirements on banks. Bonner (2012) and Bonner and Eijffinger able coupon rates by either fixing the coupon rate at the time of
(2012) investigate the impact of the Dutch liquidity requirement issuance of the item or by periodically recalculating the new par-
on interest rate charges for corporate and interbank credits using yield coupon rate for an item. As Drehmann et al. (2010), we assume
a panel regression approach. They find no evidence regarding an for simplicity that each fixed-income item exhibits the payment
impact of the liquidity requirements on these charges. Duijm and structure of a bullet loan.
Wierts (2014) and Banerjee and Mio (2015) assess bank balance In our model, the item’s specific risk-adjusted discount rate
sheet reactions to national liquidity requirements. Using an error includes the maturity-dependent risk-free spot rate, the item’s rat-
correction model, Duijm and Wierts (2014) find a long-run relation- ing specific credit risk spread, and an additional premium that
ship in the level of the liquid assets and liabilities that are included applies if the asset is subordinated. The term structure of the risk-
in the national liquidity regulation in the Netherlands. They con- free interest rate is modeled by the CIR-approach.5 This approach
clude from this that banks steer the liquidity requirements at fixed allows us to simulate a stochastic evolution of the risk-free short
target levels. Additionally, their results show that banks first react rate, whereby the interest rates cannot take negative values. The
to deviations from the long-run equilibrium by restructuring their rating-dependent credit spreads are modeled as Ornstein- Uhlen-
liabilities. The results of Banerjee and Mio (2015) indicate that beck processes introduced by Vasicek (1977). Hence, we assume
banks raise the amount of high quality and liquid assets (HQLA) as a them to be stochastic and mean- reverting, whereby the spreads
reaction to the liquidity requirements introduction in the UK. Their may become negative.6 In sum, this allows a stochastic evolution
results also show that the introduction of the liquidity require- of the present value of each fixed-income item. To incorporate
ments has no effect on balance sheet length and interest rates of dependencies between the considered processes, we assume all
loans. This latter finding confirms the results of Bonner (2012) and process-related standard normally distributed random variables to
Bonner and Eijffinger (2012) for the Dutch banking sector. be correlated.
Our model contributes to both strands of literature in several As the default risk of the issuer of an asset may change during
ways. Regarding the former, we introduce a model that consid- the life of an asset, our model also accounts for rating migrations
ers the integrated effect of multiple risk types, i.e., interest rate, of the issuers. Migrations of the issuers of fixed-income assets and
credit risk and liquidity risk. We do not investigate bank network liabilities, e.g. loans granted to corporates or long and short posi-
effects (as, e.g., Aikman et al., 2011), but, instead, we focus on a very tions in bonds, are modeled as in the CreditMetrics framework.7
detailed reproduction of the balance sheet of a single bank. Addi- In this framework, the rating migration of an issuer is driven by
tionally, our model differs from the existing models as it allows the stochastic evolution of the issuer’s asset return. In our model,
for a separate treatment of the banking book and trading book. As the stochastic asset return of each issuer depends on a latent sys-
trading book items can be sold at any time, this may improve the tematic risk factor and on an interest rate factor (both interpreted
representation of the bank’s liquidity risk. Third, we calibrate the as indicators of the macroeconomic environment in which a bank
model for the German banking sector, which has not been subject operates) as well as on an idiosyncratic component. Rating migra-
to a balance sheet simulation so far. tions occur when the asset return is higher or lower than return
We extend the latter strand of literature by investigating the thresholds that are derived from industry-specific transition matri-
simultaneous impact of both LCR and NSFR using a simulation ces. In case of default, the respective fixed-income item is liquidated
model and a detailed version of the actual Basel III calibration of instantaneously. We assume that each fixed-income item recov-
the liquidity ratios. Additionally, we do not only extend the evi- ers a fraction of its nominal value in the same period it defaults.
dence on the liquidity ratios’ impact on balance sheet growth, but Profits and losses due to changes in the market value of a fixed-
we also investigate the impact of both liquidity ratios on a bank’s income item resulting from migrations in non-default states are
default probability, equity return and contractual future cash flows. only considered for trading book items.
4. Dynamic balance sheet model 4

See Drehmann et al. (2010), p. 715 for technical details on the coupon calculation
approach.
We model the dynamics of different types of on- and off-balance 5
See Cox, Ingersoll, and Ross (1985).
6
sheet items. Fig. 1 summarizes the considered balance sheet items There is mixed evidence on the distribution of credit spreads. While Alizadeh
and states references to the sections, which verbally outline the and Gabrielsen (2013) show that credit spreads might not follow a normal distri-
bution, Kiesel, Perraudin, and Taylor (2003) show that credit spread changes are
respective balance sheet item dynamics. All technical details of our approximately normally distrbuted, at least for longer time horizons.
model can be found in Appendix A. 7
See Gupton, Finger, and Bhatia (1997).
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Fig. 1. Balance sheet structure and section referencing.

Source: Own illustration.
To allow for rating changes of the simulated bank itself during which it initially entered the balance sheet. The book value of any
the simulation period, we use the structural approach introduced non-fixed income item in the trading book equals its market value
by Merton (1974) to model the bank’s default probability in the modeled by a geometric Brownian motion.
lapse of time. This probability is linked to the bank’s rating and the
bank’s cost of debt. In the model of Merton (1974), it is assumed 4.1.3. Deposits
that the market value of an obligor’s assets evolves according to In order to account for differences between demand deposits,
a geometric Brownian motion and that a default occurs when the savings deposits and term deposits, we treat the aggregate amount
market value of the assets is lower than the debt volume when it is of each deposit type separately. As for stocks, each aggregate
due. In the resulting formula for the default probability, we insert amount is assumed to be infinitely divisible. Regarding demand
the simulated bank balance sheet volume (as proxy for the market deposits and savings deposits, we use a modeling approach that
value of the bank’s assets) and the simulated bank debt volume. takes deposit withdrawals into account when bank fundamen-
Knowing the bank’s default probability, we derive the bank’s rat- tals deteriorate.8 This enables us to capture deposit run-off risk.
ing from matching its average annual default probability with the In detail, we use the results of Domikowsky et al. (2015), who
rating-specific default probabilities of a bank-industry transition analyze the disciplining effect from depositors by employing a
matrix. The adjustment of a bank’s rating is done once a year. regression model and estimating the respective parameters for Ger-
man banks. We restrict our modeling approach to those parameters
that Domikowsky et al. (2015) identify as significant.
4.1.2. Stocks and other non-fixed income items As term deposits are characterized by fixed contract maturities,
The evolution of stocks and other non-fixed income items is cap- we model each aggregate amount that matures on a specific day.
tured by modeling the aggregate book value of each balance sheet
item. For simplicity, each of these aggregate amounts is assumed
to be infinitely divisible. We use the same valuation approach 8
See, e.g., Pfingsten, Sträter, and Wissing (2008), Hasan, Jackowicz, Kowalewski,
for stocks and other non-fixed-income items that we used for and Kozłowski (2013), Domikowsky, Kaposty, and Pfingsten (2015) and Lamers
fixed-income items. Hence, the aggregate book value of the non- (2015) for empirical evidence showing that a deposit run-off can be triggered by
fixed-income items in the banking book equals the value with deteriorating bank fundamentals.
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Instead of assuming a stochastic process, we rely on an assump- 4.2. Reinvestment rules

tion with respect to the prolongation of term deposits in order
to describe their evolution over time. To keep things simple, we As it is common for dynamic balance sheet models, we have to
assume that each amount of maturing term deposits is entirely pro- rely on some necessary reinvestment rules. Therefore, we use three
longed. For prolongation purposes, the maturing aggregate amount basic assumptions. First, we assume that no investment restrictions
is allocated over each future day according to the initial maturity exist (i.e., there are no restrictions on the demand side of capi-
distribution of term deposits. tal markets). Hence, for example, there will always be at least one
In order to model the interest payments that the bank has to market participant that has a demand for a specific loan. Second, we
pay to its depositors, we need to specify the deposit rate. In model- assume for simplicity that the bank cannot sell banking book items
ing this rate, we follow Kalkbrener and Willing (2004).9 According before maturity. In particular, this implies that the bank cannot sell
to their approach, the deposit rate is described as a continuous banking book items at short notice to mitigate liquidity shortfalls
deterministic function of the stochastic risk-free short rate (see Sec- and arbitrarily steer its term transformation in any period. How-
tion 4.1.1). Since the short rate is restricted to non-negative values, ever, third, we assume that the bank can manage its liquidity needs
the deposit rate is restricted to positive values. We assume that by overnight repurchase agreements. For this, eligible collaterals
the same deposit rate can be applied to demand deposits, savings are only bonds held in the banking book. For simplicity, we assume
deposits and term deposits. Hence, term deposits with long matu- a haircut of zero.
rities are subject to the same deposit rate as savings deposits. This, Following Aikman et al. (2011), we assume a long-term equi-
of course, is a simplifying assumption. librium of the bank balance sheet structure, which is given by the
balance sheet structure in t = 0. Hence, the bank borrows on dif-
4.1.4. Off-balance sheet items ferent types of liabilities and invests in different types of assets
In our model, we restrict off-balance sheet items to undrawn aiming to reach this specific structure in each period. As bank equity
amounts of credit facilities that have irrevocably been committed and the total volume of the balance sheet evolve endogenously, we
to non-bank obligors. While the drawn amount of each facility is use it as a natural starting point for setting up the reinvestment
treated as a loan, the respective undrawn amount is treated as off- rules. We use the equilibrium equity ratio to determine the required
balance sheet facility. amount of liabilities, i.e., the amount of liabilities that closes the gap
We model the evolution of each facility separately and match it between the equilibrium equity ratio and the actual equity ratio in
to a specific loan in the banking book. This enables an integrated period t.
modeling of the evolution of the drawn and undrawn parts of the On the asset side, the bank only invests in risky assets, if the
facilities. In our model, the undrawn amount of a credit facility cash account plus the newly acquired cash from new liabilities is
depends on the rating of the obligor, as the drawn share of a credit larger than the respective equilibrium amount that results from
facility typically rises when the obligor’s rating worsens.10 Since the initial relation between the cash account and the total balance
obligors regularly draw extensively on committed credit facilities sheet volume. Whenever this holds, the bank invests its excess cash
prior to default,11 we model an additional usage of the facility in amount, i.e., the money that exceeds its equilibrium amount. To
the default event. reach the asset side equilibrium, the bank uses a similar approach
it uses for borrowing.
Besides the introduced regular borrowing and investment deci-
4.1.5. Profit and loss calculation sions, we allow for transitory deviations from the equilibrium
To ensure a structural calculation of the banks’ equity in each balance sheet structure to avoid liquidity shortfalls. Whenever the
period, we use the profit and loss calculation. This calculation actual cash amount is lower than the equilibrium amount, the bank
includes all cash flows and value changes that affect the net income. acquires additional cash to reach the cash account equilibrium. The
Thus, it includes received coupon payments, losses from defaulted bank tries to attain this additional amount of cash by first borrow-
items, paid interests on deposits and the value changes of assets ing on bonds held in its banking book, i.e., conducting overnight
and liabilities held in the trading book. repurchase agreements. If the bank is not able to acquire enough
We also take into account that the bank pays taxes on its cumu- cash with repurchase agreements, it sells assets held in the trad-
lated profit at the end of each year. As these tax payments may be ing book. In doing so, it sells both stocks and fixed-income items
large, we assume the bank makes liquidity provisions for its year- according the relative proportion of their aggregate book values.
end tax payment. This provision develops according to a fixed tax
rate and the banks’ cumulative profits.
5. Parameterization
4.1.6. Cash flow calculation
Similar to the banks’ equity, its cash account evolves according 5.1. Initial balance sheets
to the cash flow calculation. This calculation includes the received
coupon payments, notional amounts of maturing items and recov- The parameterization of our model comprises both the construc-
ering amounts of defaulted items of all fixed-income assets and tion of an initial balance sheet and the calibration of the model’s
fixed-income liabilities in the balance sheet. Additionally, it cap- parameters. Regarding the initial balance sheet, we use private
tures the interest payments to depositors, the net changes in the information from the Deutsche Bundesbank to construct 9 different
aggregate volume of deposits and the net change in the bank’s off- stylized balance sheets for German banks by averaging the balance
balance sheet items. Due to the tax provisions, the evolution of the sheets of 5 randomly chosen banks according to their sector affili-
cash amount is not only affected by the cash flow calculation but ation and size (measured by their balance sheet volume) as given
also by the respective tax provisions. in Table 1. The balance sheets are as of 31st December 2013.
In order to fully parameterize the balance sheet, we need infor-
mation about aggregate balance sheet amounts for each asset and
9
liability as well as single principal amounts, ratings, maturities,
The authors calibrate their deposit rate process for a German deposit rate. The
calibrated process shows a good fit to the used deposit rate data.
and obligor types for all fixed-income items. The required data
10
See, e. g., Asarnow and Marker (1995), Duffy et al. (2005) and Jacobs (2010). is compiled by using two different databases from the Deutsche
11
See, e. g., Araten and Jacobs (2001) and Jiménez, Lopez, and Saurina (2009). Bundesbank.
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Table 1 and liabilities maturing within 12 months. In detail, this database

Bank sectors and sizes.
allocates all fixed-income assets and liabilities maturing within the
Savings banks Cooperative banks Private banks next 12 months to a first bucket (up to 1 month), a second bucket
Small banks BS ≤ 4 bn. BS ≤ 2 bn. BS ≤ 2 bn. (more than 1 month and up to 3 months), a third bucket (more than
Medium banks 4 bn. < BS ≤ 8 bn. 2 bn. < BS ≤ 4 bn. 2 bn. < BS ≤ 14 bn. 3 months and up to 6 months) and a fourth bucket (more than 6
Large banks BS > 8 bn. BS > 4 bn. BS > 14 bn. months and up to 12 months).
Source: Own computations, BS: balance sheet volume, figures given in Euro. We merge the information of both databases by replacing the
short term maturity bucket of the BISTA-database by the maturity
buckets given in the BAKIS-database. However, this merge comes
From the BISTA-database, we obtain aggregate amounts of each
with some challenges as both databases are based on different
considered type of balance sheet item. The database also holds
accounting rules. In detail, in contrast to the book values in the
information on the portion of variable or fixed coupons for all
BAKIS-database, book values in the BISTA- database do not contain
asset types but interbank assets, which we use as a starting point
accrued interest. Moreover, and even more important, the maturity
for determining the repricing of assets. However, we need to
buckets in the BAKIS-database refer to original maturities, while
supplement this information with further assumptions to fully
maturity buckets in the BISTA-database refer to residual maturities.
specify the repricing methodology for the simulation purpose. First,
In sum, both differences lead to larger book values in the BISTA-
in line with empirical results, we assume that interbank assets
database. As both databases provide aggregate information, there is
are fully variably priced.12 Second, the portion of variably priced
no possibility to transform the maturities to a common accounting
fixed-income liabilities is set to equal its counterpart on the asset-
standard. We handle this issue by re-sizing the aggregate matu-
side of the balance sheet. Hence, the portion of variably priced
rity buckets’ amounts of the BAKIS-database to the aggregate book
interbank liabilities also amounts to 100%. As there is no counter-
value of the respective short-term maturity bucket of the BISTA-
part for securitized liabilities and subordinated liabilities on the
database. In doing so, we are aware that this does not cure from the
asset side, we set the shares for variably priced securitized lia-
differences between both databases, but prioritize more detailed
bilities to 44.73% and for variably priced subordinated liabilities
information on the short maturities of assets and liabilities, because
to 3.91%, respectively.13 Third and last, we assume that when-
detailed information on short maturities is especially crucial for the
ever the coupon rate is variable, it will reprice immediately after a
representation of banks’ short-term liquidity risk.
coupon payment. Additionally, we also collect the industry sector
Finally, as there is no information on the maturity distribution
distributions of fixed-income items from the BISTA-database. The
of securitized and subordinated liabilities, we use a naive approach
database contains the sector distribution (banks, public authori-
and assume that they are uniformly distributed within a maturity
ties and corporates) of fixed-income assets and liabilities but the
bucket starting at one day and closing at 120 months. The same
fixed- income items on the liability side of the trading book. As
upper threshold is used for all long-term maturity buckets from
fixed-income trading book liabilities comprise short positions in
the BISTA-database.
financial instruments, we assume that its sector distribution equals
Concerning the rating information, we separate between the
the sector distribution of fixed-income assets in the trading book.
bank’s own rating and the ratings of its obligors. While the bank’s
This follows the idea that a bank or trader having special knowl-
own initial rating is calculated as the average of the ratings of
edge on a specific industry will be more active in both short
the respective five randomly drawn banks, we derive the oblig-
selling and buying financial instruments issued by that indus-
ors’ ratings based on information of the BAKIS-database. As the
try.
data is grouped in default probability buckets for financial and non-
Maturity information is compiled from the BISTA-database
financial obligors, we map the aggregate amounts to rating classes
and BAKIS-database, since both databases contain complemen-
by using the default probabilities from the respective transition
tary maturity information given in maturity buckets. In detail, the
matrices shown in Table 2.15 After that, we allocate the resulting
BISTA-database contains information for all types of fixed-income
rating class-specific amounts to all valid balance sheet item types
assets and liabilities, but securitized and subordinated liabilities.
according to their relative portion. For example, if loans to banks
In this database, fixed-income assets are allocated in a short-
constitute 60 per cent of all assets obliged by banks, than 60 per
term maturity bucket (up to 12 months), a medium-term maturity
cent of each rating-specific amount related to financial obligors is
bucket (more than 12 months and up to 60 months) and a long-term
allocated to that item type.
maturity bucket (more than 60 months). Regarding fixed-income
Fig. 2 summarizes the compiled data by using a balance sheet
liabilities, the short-term maturity buckets have the same thresh-
representation. Due to disclosure restrictions, we stick to a general
olds as the assets’ buckets. However, the medium-term liability
form of illustration. This balance sheet is used as starting point in
bucket comprises fixed-income items with a maturity more than 12
our simulation and serves as long-term equilibrium for our simu-
months and up to 24 months. Accordingly, the long-term liability
lation.
buckets contain liabilities with a maturity larger than 24 months. As
The balance sheet shown in Fig. 2 complies with general
interbank assets and liabilities may have no contractual maturity,
accounting requirements. For example, the amounts of each item
there is an additional bucket for interbank assets and liabilities that
characteristic, i.e. ratings, sum up to the respective aggregate
contains the respective items.14 In contrast to the BISTA-database,
amounts. For example, the sum of all rating-specific interbank
the BAKIS-database contains more detailed information on assets
assets equals the total amount of interbank assets. In order to
ensure the sum of asset and liability types equaling the balance
sheet length, we add two respective residual amounts, ARES and
12
See, e.g., Alessandri and Drehmann (2010). The authors show that the portion
LRES. As they simply serve as instruments to ensure both a realistic
of variably priced interbank assets at banks is close to 100%.
13
This is the outstanding amount of (subordinated, securitized) bonds with vari-
able coupons issued by the banks in our sample divided by the respective total
outstanding amount of (subordinated, securitized) bonds issued by the banks in
15
our sample as of 31th December 2013 according to data from Thomson Reuters For the financial obligors, we use the default probabilities from Table 2 (a). As
Datastream. non-financial obligors comprise corporates and public authorities, we employ the
14
Interbank items without contractual maturity include for example interbank volume- weighted rating-specific default probabilities from the Table 2 (b) and (c) by
deposits. As these items may be withdrawn at any time, we treat these items as using the amounts from the BISTA-database for the corporate and public authority
fixed-income items with instantaneous maturity. sector.
G Model
Fig. 2. Initial balance sheet.

(·) (·)
Source: Own illustration. B̂ denotes the aggregate balance sheet amount for each item type. The relative portions of each characteristic are given by ı(·) . The relative portion
of each rating class varies with the obligor type ST.
balance sheet length and the fulfillment of the balance sheet iden- specific item type is in general lower than the respective aggregate
tity at the simulation’s starting point, both are treated as constants amounts. We fill these gaps by using amounts that are uniformly
throughout the simulation. distributed between exposures sizes of ten thousands and 1.5 mil-
As our modeling approach for fixed-income items requires lion euros. After knowing the distribution of single exposures for
single obligor-specific exposures, we break down the aggregate fixed-income assets, we derive the single exposure distribution for
amount of each item type and its characteristics into single expo- fixed-income liabilities. This is done by applying the realized asset
sures. Therefore, we also use data from the BAKIS-database, which type-specific concentrations, as measured by the Lorenz curve,
contains single obligor-specific exposures (referring to assets, not to the asset types’ respective counterparts on the liabilities side.
liabilities) that are larger than 1.5 million euros.16 After averaging For example, we derive the sizes for single interbank liabilities by
the data across sample banks by using the mean Lorenz curve, we applying the Lorenz curve from the interbank assets on the aggre-
allocate the single exposures to all valid fixed-income asset types gate interbank liabilities exposure. Since there are no counterparts
by using the greedy algorithm.17 Since the allocation only com- for securitized and subordinated liabilities, we use a naive approach
prises large exposures, the sum of exposure sizes allocated to each and assume that they follow the average interbank exposure size
as is given in the BISTA-database.
Finally, we allocate the aggregate amounts that relate to spe-
16
cific characteristics, e.g., the item’s rating, to the respective single
This data is only available for banks using the IRB approach. Since our sample
fixed-income item exposures. This is done by applying the greedy
also includes banks that do not use the IRB approach, we implicitly assume that the
loans of IRB- and non-IRB bank exhibit a similar size distribution. algorithm independently on each item type and characteristic.
17
For technical details regarding the averaging Lorenz curve, see, e.g., Thus, we treat all allocations as independent optimization prob-
Lütkebohmert (2009). For technical details on the greedy algorithm, see, e.g., lems.
Kellerer, Pferschy, and Pisinger (2004).
G Model
Table 2
Sector-specific one-year transition matrices.
Initial rating Rating 1 year later
AAA AA A BBB BB B CCC-C D NR
(a) Banks
AAA 86.63 7.54 0.50 0.20 0.10 0.00 0.00 0.00 5.03
AA 0.38 85.29 9.70 0.43 0.00 0.00 0.00 0.03 4.18
A 0.03 2.45 86.51 4.62 0.29 0.07 0.01 0.08 5.94
BBB 0.00 0.33 4.43 82.90 3.59 0.59 0.06 0.41 7.69
BB 0.00 0.13 0.13 6.53 74.36 5.30 0.93 1.06 11.56
B 0.00 0.00 0.06 0.37 8.18 73.53 2.93 3.43 11.49
CCC-C 0.00 0.00 0.00 0.00 1.55 16.67 45.74 15.12 20.93
(b) Corporates
AAA 86.90 8.17 0.81 0.00 0.07 0.00 0.00 0.00 4.05
AA 0.57 86.63 7.70 0.72 0.10 0.15 0.00 0.00 4.13
A 0.04 1.27 87.24 6.46 0.42 0.20 0.02 0.03 4.31
BBB 0.01 0.06 3.08 85.94 4.03 0.63 0.12 0.17 5.95
BB 0.02 0.02 0.14 4.83 76.52 7.62 0.65 0.83 9.37
B 0.00 0.03 0.11 0.20 5.11 73.93 4.54 4.37 11.71
CCC-C 0.00 0.00 0.19 0.28 0.57 13.43 43.64 28.32 13.57
(c) Public authorities

AAA 96.0 4.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0
AA 1.9 90.7 6.0 1.4 0.0 0.0 0.0 0.0 0.0
A 0.0 3.1 90.3 5.5 0.8 0.3 0.0 0.0 0.0
BBB 0.0 0.0 5.4 87.0 6.5 1.0 0.2 0.0 0.0
BB 0.0 0.0 0.0 5.3 84.2 7.8 1.4 1.3 0.0
B 0.0 0.0 0.0 0.0 8.8 85.5 2.4 2.0 1.3
CCC-C 0.0 0.0 0.0 0.0 0.0 34.8 60.3 4.9 0.0
Source: Standard and Poor’s (2013a), Table 43 and 44; Standard and Poor’s (2013b), Table 14.
Table 3 Table 6
Parameters of the short-rate process. Parameters of the sector-specific loss-given-defaults.
Process Parameter Sector Parameter
r r r ˛c ˇc
CIR-process 0.2552 0.0028 0.0331 0.5 Banks 0.2822 0.3450

Corporates 0.4126 0.6454
Source: Own computation. The parameter value of is chosen in line with literature,
Public authorities 1.3374 1.3809
see, e.g., Bernaschi, Torosantucci, and Uboldi (2007) , Ahmad and Wilmott (2007),
Huang and Huang (2003) and Grundke (2011) . Source: Own computation based on Memmel, Sachs, and Stein (2012), Davydenko
and Franks (2008), and Moody’s (2012).
Table 4
Parameters of the credit spread process.
Table 7
Rating class Parameter Parameters of the stock process.
r r r g Variable Parameter
AAA (k = 1) 0.0038 0.0013 nf nf

AA (k = 2) 0.0043 0.0013
Geometric brownian motion 0.0369 0.2256
A (k = 3) 0.0063 0.0020
BBB (k = 4) 0.4 0.0090 0.0028 0.03 Source: Own computation based on EuroStoxx50.
BB (k = 5) 0.0175 0.0057
B (k = 6) 0.0347 0.0097
CCC-C (k = 7) 0.1110 0.0326 Table 8
Parameters of the deposit rate.
Source: Own computation based on Kiesel et al. (2003) and assumptions. We set
the parameter g to be roughly in line with the surcharge on subordinated debt of Variable Parameter
European banks.
aD bD cD uD
Table 5
Deposit rate 0.0112 0.0080 0.2000 0.0340
Parameters of the sector-specific CreditMetrics asset return equation.
Source: Own computation based on data from the Deutsche Bundesbank.
Sector Parameter
b r,b
5.2. Parameter values
Banks 0.7716 0.0277
Others 0.5213 0.0096
Given the available data, we are able to estimate most of
Source: Own computation based on Euribor1w and stocks listed in EuroStoxx50.
the required parameters of the balance sheet model’s processes
G Model
Table 9
Sector-specific return thresholds.
Initial rating Rating 1 day later
AA A BBB BB B CCC-C D
Banks
AAA −3.3725 −4.1530 −4.2078 −4.4346 −5.9637 −6.1114 −6.1595
AA 3.5800 −3.3232 −4.2977 −4.7319 −4.7324 −4.7325 −4.7326
A 5.6124 3.6812 −3.5044 −4.1802 −4.3946 −4.5084 −4.5338
BBB 5.9805 4.2069 3.5124 −3.5175 −3.9357 −4.1250 −4.1464
BB 6.0967 4.3675 4.3662 3.3943 −3.3742 −3.7379 −3.9435
B 5.5932 5.5705 4.5322 4.4818 3.3244 −3.4032 −3.6207
CCC-C 6.7638 6.3144 5.8939 5.6257 3.9380 3.0247 −3.1016
Corporates
AAA −3.3475 −4.0655 −4.5149 −4.5154 −5.5624 −5.5898 −6.4472
AA 3.4760 −3.3743 −4.0232 −4.2770 −4.3632 −5.8928 −6.0527
A 5.6584 3.8480 −3.4186 −4.0915 −4.2868 −4.7039 −4.8185
BBB 4.9531 4.6003 3.6250 −3.5102 −4.0051 −4.2491 −4.4090
BB 4.7605 4.6358 4.4612 3.4863 −3.3225 −3.8841 −4.0554
B 6.1755 4.6659 4.3586 4.3173 3.4487 −3.3094 −3.6045
CCC-C 5.6082 5.5906 4.2294 4.0219 3.9895 3.0975 −2.9154
Public authorities
AAA −3.5759 −5.1457 −5.1808 −5.1891 −5.5335 −6.1581 −6.7793
AA 3.7722 −3.4172 −3.8689 −5.3281 −5.3766 −5.3879 −5.3889
A 5.7140 3.6402 −3.4475 −3.9572 −4.2386 −5.7806 −5.9774
BBB 5.3051 5.2579 3.4890 −3.3996 −3.9569 −4.3309 −5.6175
BB 6.6563 5.0953 5.0650 3.4836 −3.3080 −3.6679 −3.8866
B 6.2403 6.1954 4.8827 4.8640 3.3402 −3.5271 −3.7731
CCC-C 7.1117 5.7042 5.6759 4.4383 4.4200 2.8912 −3.5051
Source: Own computation. We derived the thresholds by applying the algorithms from Israel, Rosenthal, and Wei (2001) and Gupton et al. (1997) to the transition matrices
shown in Table 2.
by ourselves. Own estimations are based on data spanning the Table 10

Rating-specific undrawn shares of off-balance sheet facilities.
time interval from 01 January 2010 to 31st December 2013. We
separate between bank-specific processes and general or macroe- Rating class Parameter
conomic processes that are commonly valid for all nine generated
uk uk,8
banks. We use monthly data for bank’s equity and balance sheet
AAA (k = 1) 0.001 0.6893
length from the BISTA- database to individually estimate the
AA (k = 2) 0.016 0.7183
parameters for the bank’s own default probability (Eq. (11)).18 A (k = 3) 0.046 0.6773
The other process parameters are simultaneously valid for all BBB (k = 4) 0.200 0.5200
banks. The parameter estimation of the risk-free short rate pro- BB (k = 5) 0.468 0.2766
cess (Eq. (5)) is based on daily observations of the Euribor1w. B (k = 6) 0.637 0.1742
CCC-C (k = 7) 0.750 0.1100
The parameters of the obligors’ asset returns (Eq. (7)) are esti-
mated based on daily observations of individuals stock prices from Source: Own computation based on Asarnow and Marker (1995).
members of the EuroStoxx50, whereby we use the index com-
position as of 31st December 2013. In order to obtain different Table 11
parameters for financial and non-financial customers, we sepa- Bank initial ratings and parameters of default probability processes.
rately estimate the parameters for companies with the respective Sector Initial rating BS BS
business sector affiliation. Estimations of the stock return param- 1. Savings banks
eters (Eq. (13)) are also performed based on daily observations of Large AA 0.0070 0.0192
the EuroStoxx50. Medium AA 0.0094 0.0171
Small AA 0.0125 0.0198
The remaining required parameters are derived from the litera-
ture. To obtain a calibration for German banks, we attempt to only 2. Cooperative banks
Large AA 0.0208 0.0193
consider results from the empirical literature using German or at
Medium AA 0.0254 0.0212
least European data. Tables 2–11 give an overview on all employed Small AA 0.0263 0.0245
process parameters.
3. Private banks
Large A 0.0363 0.0352
Medium BBB 0.0332 0.0363
Small BBB 0.1304 0.0888
Source: Own computation based on data from Deutsche Bundesbank.
18
All equation numbers refer to Appendix A.
G Model
Table 12
Correlations.
Macr. factor Int. rate factor Credit spreads Stocks Deposits
Y Xr ε1 ε2 ε3 ε4 ε5 ε6 ε7 εa εp εDD εSD
(a) Overall valid correlations

Macr. factor Y 1
Int. rate factor Xr 0 1
ε1 0 −0.3 1
ε2 0 −0.3 0.915 1
ε3 0 −0.3 0.790 0.845 1
Credit
ε4 0 −0.3 0.705 0.710 0.915 1
spreads
ε5 0 −0.3 0.690 0.720 0.835 0.820 1
ε6 0 −0.3 0.660 0.670 0.720 0.700 0.705 1
ε7 0 −0.3 0.660 0.660 0.670 0.720 0.700 0.705 1
εa 0 0.0162 0.2 0.2 0.2 0.2 0.2 0.2 0.2 1
Stocks
εp 0 0.0162 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0 1
εDD 0 εi ,X 0 0 0 0 0 0 0 εi DD ,εa 0 1
Deposits DD r
εSD 0 εi 0 0 0 0 0 0 0 εi SD ,εa 0 εi SD ,εDD 1
SD ,Xr
Sector Private banks Savings banks Cooperative banks
Size Large Medium Small Large Medium Small Large Medium Small
(b) Bank-specific correlations

εi ,X 0.0121 −0.0848 0.1039 −0.0225 0.0088 −0.0162 0.0013 −0.0223 0.0165
DD r
εi −0.1279 −0.2313 0.1150 −0.0323 0.2365 0.0808 −0.1919 0.0351 0.1174
SD ,Xr
εi DD ,εa 0.2279 0.1541 −0.0589 0.1942 −0.0531 0.1734 0.2113 0.0623 0.1276
εi SD ,εa 0.1237 0.0183 0.0805 −0.0198 −0.1579 0.0524 −0.0058 −0.0679 0.1281
εi SD ,εDD 0.3599 0.1759 0.3304 −0.2143 −0.1146 0.0510 −0.5555 0.4198 −0.0866
Source: (a) Own computation, Kiesel et al. (2003), and assumptions based on Batten et al. (2005), Chen et al. (2011) , and Scheicher (2009); (b) Own computation based on
data from Deutsche Bundesbank and Euribor1w.
Additionally, the deposit volume processes are calibrated by requirements.22 To be able to apply the regulatory risk weights,
relying on the parameters of Domikowsky et al. (2015).19 In order we need to rely on some additional assumptions. First, we use
to quantify the magnitude of the processes’ stochastic dependen- a naive distribution across the relevant deposits outflow factor
cies, we also need to calibrate the processes’ correlations. Except for determinants. In detail, we assume that all deposits are equally dis-
the pairwise credit spread correlations, which are taken from Kiesel tributed across private and institutional depositors. Deposits from
et al. (2003), and the assumed correlations between rating-specific institutional depositors are held for operational purpose and other
credit spreads and stocks, which are set in line with empirical purposes at equal shares. Moreover, independently from the pur-
evidence from the literature (see, e.g., Chen, Liao, and Tsai, 2011, pose of the deposits, we assume that half of it is secured by a deposit
Batten, Hogan, and Jacoby, 2005, Scheicher, 2009), the entailed insurance. As the requirements for stable retail deposits are very
correlations are derived by own estimations based on data from strict, we generally set retail savings deposits to be less stable. How-
EuroStoxx50, Euribor1w and deposit data from the Bundesbank. ever, as sight deposits are often held on checking accounts and thus
The correlation matrix is shown in Table 12. fulfill the requirements for stable deposits, we consider 90% of the
Finally, the banks’ tax rate is assumed to be given by TR = 0.5. sight deposits from retail depositors as stable.
Further, we consider three different scenarios for simulation
6. Results purposes. Besides a regular, non-stress scenario, we consider an
interest rate stress scenario and a macroeconomic stress scenario.
For simulation purposes, we use small simulation steps, i.e., The macroeconomic stress scenario lasts half a year and exhibits
t = 1 day, and a simulation horizon of N = 756 days (three years a severity of two standard deviations, i.e., we set Y = −2 for the
consisting of 252 business days). In line with the literature, we first 126 business days of the simulation. The interest rate stress
assume that the bank is risk averse20 and, thus, aims at target val- scenario is set to last one year and also has a severity of two stan-
ues for the liquidity ratios that are above the legal requirement. As dard deviations, i.e., we set Xr = −2 for the first 252 business days
the LCR is expected to be more volatile than the NSFR, we assume of the simulation. By doing so, we get a downward-shifted and
target ratios for the LCR = 1.2 and NSFR = 1.1, respectively.21 Due steeper term structure of risk-free spot yields23 whereby the lat-
to the business day calibration, we the set the LCR’s risk horizon ter is a favorable situation for the net interest income of banks,
to 21 days, while the NSFR’s risk horizon is 252 days. Further- as they usually perform positive maturity transformation. How-
more, both liquidity ratios are calibrated as defined by the legal ever, due to the positive correlation between the interest rate factor
Xr and the obligors’ asset returns (see Eq. (7)), the probability for
19
Since Domikowsky et al. (2015) only report the results of a full sample of German
22
banks, they kindly provided results for each banking group separately. Due to disclo- The weighting factors can be found in BCBS (2013), BCBS (2014a). A summary
sure restrictions, these results could not be shown explicitly. However, the results of the used weighting factors is available upon request.
23
do qualitatively not differ from the results shown in Domikowsky et al. (2015), Table The long-run mean in the CIR-process for the risk-free short rate is only 28 basis
4, Nos. 1 and 2. points (see Table 3) and the spot rate for a maturity of 10 years is only 29 basis
20
See, e.g., Haan and van den End (2013) and Bonner, van Lelyveld, and Zymek points in the non-stress scenario. Thus, as the calibration of the short rate process
(2014). has been done in a low interest rate environment, the absolute effects of the interest
21
Both target ratios have been set on ad-hoc assumptions. However, the ratios rate stress scenario on the term structure of risk-free spot rates are pretty small. For
seem to comply with current practice as the median of large banks exhibits similar short maturities, we have a downward shift only by around 28 basis points and the
LCR and NSFR values in the Basel III quantitative impact study (see BCBS, 2014a, spread between the spot rate for a maturity of ten years and the shortest maturity
Table 20). increases from 1 basis point to 18 basis points.
G Model
downward rating migrations and defaults of the bank’s obligors within the lower quartile of the respective empirical distribution of
increases. Moreover, due to the negative correlation between the Group 2 banks. While the first peculiarity can be traced back to cash
interest rate factor Xr and the credit spreads, we also have effects inflows that reach the LCR’s upper limit regarding cash inflows,26
on the mark-to-market values of fixed-income assets in the trading there are at least two possible reasons for the second peculiarity.
book as well as on the value of coupons paid and received by the One possible reason relates to differences between our sample of
bank. Because of these multi-facet effects in the interest rate stress banks and the sample used in the quantitative impact study. Espe-
scenario, it is à priori not obvious whether in sum this is indeed a cially, since the information on the liquidity ratios is submitted on
‘stress’ (i.e., extremely negative) scenario for the bank. a voluntary basis, only banks with large LCR values may participate
In order to assess the effect of the liquidity ratios on our analysis in the quantitative impact study. The other possible reason relates
measures within each scenario, we consider three different rules to the assumption on the deposits distribution used in the calcula-
regarding bank behavior. Under the first rule, the bank does not tion of the liquidity ratios. If this assumption results in a portion of
react to the liquidity ratio’s values, which is the same as assuming retail depositors that is lower than the true portion, outflows are
their non- existence. This rule is, hence, used as benchmark. Under overestimated and the LCR is lower than the true value. Since sav-
the second rule, the bank gears the liquidity ratios by investing in ings banks and cooperative banks heavily rely on deposit funding,
sovereign bonds as those financial instruments generally qualify this would also explain the magnitude of the effect.
as HQLA.24 Thus, the bank tries to increase the numerator of the In sum, both reasons have a different implication for our results.
LCR by using this reaction rule. However, since interdependencies When the first reason holds, the model-based LCR values of savings
between both measures exist, this reaction typically also leads to banks and cooperative banks are still correct. If the second reason
increasing NSFR values. In detail, the reason for this is that sovereign holds, we underestimate the LCR values in the model. This would
bonds c. p. require less stable funding than other assets, such as e.g. lead to an overestimation of the LCR’s impact on our four analysis
private sector bonds with speculative grade ratings. As third rule, measures due to an exaggerated reaction of the bank to comply
we assume a shortening of the banks’ maturity transformation.25 with the target value for LCR.
This reaction rule predominantly aims at increasing the ASF while Tables 14–16 show the simulation results regarding the ratios’
decreasing the RSF of the NSFR, thereby increasing the overall NSFR distributions and the relative frequencies of reaching the ratios’
value. Additionally, it also may increase the LCR value, because target values across all 9 banks in all 9 scenarios. While the ratios’
a shortening of the maturity transformation may lead to higher distributions are described by their means, (·), and their standard
inflows and less outflows within the next 21 business days. Thus, deviations, (·), the relative frequencies of being below or remain-
the reaction rule may lead to lower values of the denominator of ing above the ratios’ target values, respectively, are given by P(·).
the LCR, which, in turn, increases the overall LCR value. For scenarios in which the reaction rules are in place, the proba-
In order to assess the goodness-of-fit of the calibration of both bility depends on the binary variable, S(·), whose value is one, if
liquidity ratios in the model, we compare the liquidity ratios’ val- the bank reacts to the respective liquidity ratio (because it is below
ues resulting from applying the ratios’ weights to the items in the the respective target value), zero otherwise. In case the banks do
constructed initial balance sheets with the liquidity ratios’ val- not react to the liquidity ratios, relative frequencies are computed
ues presented in a quantitative impact study. Since our calibration by comparing the liquidity ratios’ joint values with the respective
relies on balance sheet information as of 31st December 2013, we target values. As the results on P(SLCR = 0 ∧ SNSFR = 0) show, both
compare our results with the quantitative impact study that uses reaction rules lead to higher frequencies of remaining above the
data from the same point in time. The results of the comparison are ratios’ target values. This result holds especially for private banks.
summarized in Table 13. The reason for the lower magnitude of the reaction rules’ impact for
Table 13 shows that the liquidity ratios’ values resulting from savings and cooperative banks can be traced back to the low initial
the hypothetical balance sheets are roughly within the range of the ratios’ values. For example, savings banks exhibit low initial values
liquidity ratios’ values in the study. On the one hand, the calculated of LCR and NSFR and are not able to get above their ratios’ target
values of both ratios are within the respective empirical span width. values in all three considered scenarios when using reaction rule 1,
On the other hand, our results also reflect the scattering of both as the results on P (SLCR = 1 ∧ SNSFR = 1) indicate. However, savings
liquidity ratios. While LCR values exhibit a large variation, NSFR banks are sometimes able to get above the liquidity ratios’ target
values are close together across banks. values when using reaction rule 2. A similar pattern shows for coop-
Table 13 also shows two peculiarities. First, the model-based LCR erative banks. For this banking sector, the results also show lower
value of small private banks is above four and, hence, is much larger values of P (SLCR = 1 ∧ SNSFR = 1) when using reaction rule 2 com-
than the LCR values of all other banks. Second, the model-based pared to using reaction rule 1. This indicates that reaction rule 2 is
LCR values of all savings banks and cooperative banks are located more effective in reaching the liquidity ratios’ targets than reaction
rule 1. This result is not surprising since reaction rule 2 addresses
more balance sheet items than reaction rule 1.
The results on P (SLCR = 1 ∧ SNSFR = 1) also indicate that the
24
The technical implementation of this rule is derived by changing the balance scenario influences the value of the liquidity ratios. In the macroe-
sheet equilibrium for the obligors of bonds. In detail, we differentiate between two conomic stress scenarios, banks tend to be more frequently below
cases: Case 1: The bank reaches the target ratios of both the LCR and the NSFR:
It invests to reach its intended balance sheet structure equilibrium (see first rule).
the target values of both liquidity ratios. In general, this result is
Case 2: The bank reaches neither the target ratio of the LCR nor the target ratio of the in line with our expectations, because staying above the liquidity
NSFR: The total amount of bond investments is only invested in sovereign bonds. ratios’ target values should be more difficult in stress situations.
25
The technical implementation is also derived by changing the balance sheet With respect to the interest rate scenario, due to the conflicting
equilibrium. For implementing this rule, we have to differentiate between four
effects discussed above, we had no clear expectation what the
cases: Case 1: The bank reaches the target ratios of both the LCR and the NSFR:
It invests to reach its intended balance sheet structure equilibrium (see first rule). consequences for the simulation results would be. Tables 14–16
Case 2: The bank only reaches the target ratio of the LCR: It borrows on liabilities show that the banks’ relative frequency P (SLCR = 1 ∧ SNSFR = 1) of
with a maturity above 21 days and invests in assets with a maximum maturity of not remaining above the ratios’ target values on average decreases
21 days. Case 3: The bank only reaches the target ratio of the NSFR: It borrows on
liabilities with a maturity above 252 days and invests in assets with a maximum
maturity of 252 days. Case 4: The bank reaches neither the target ratio of the LCR
nor the target ratio of the NSFR: It borrows on liabilities with a maturity above 252
26
days and invests in assets with a maximum maturity of 21 days. This is also observed in practice (see, e.g., BCBS, 2014b).
G Model
Table 13
Results of the comparison of the initial balance sheets’ liquidity ratio values with the liquidity ratio values from a quantitative impact study.
Sector Liquidity ratio
LCR NSFR
(a) Initial balance sheet Private banks

Large 1.5591 1.0081
Medium 1.2895 0.9961
Small 4.5278 1.1125
Savings banks
Large 0.6778 0.9693
Medium 0.3081 0.9129
Small 0.2988 0.9085
Cooperative banks
Large 0.6061 0.9901
Medium 0.3908 0.9685
Small 0.3679 0.9443
(b) QIS-Study Group 1 (international banks, whose tier 1 equity exceeds 3bn euro) max ≈ 3.58 max ≈ 1.74
q0.75 ≈ 1.36 q0.75 ≈ 1.18
q0.50 ≈ 1.18 q0.50 ≈ 1.10
q0.25 ≈ 1.01 q0.25 ≈ 0.99
min ≈ 0.43 min ≈ 0.61
Group 2 (other banks) max > 4.0 max ≈ 5.29

q0.75 ≈ 2.90 q0.75 ≈ 1.35
q0.50 ≈ 1.56 q0.50 ≈ 1.17
q0.25 ≈ 1.01 q0.25 ≈ 1.05
min ≈ 0.11 min ≈ 0.07
Source: (a) Own computation; (b) BCBS (2014b), Table 20.
in the interest rate stress scenario. This indicates that in effect the reinvestment rules, which aims at keeping a constant rating dis-
interest rate stress scenario makes it easier for banks to stay above tribution. In sum, the effects lead to a decrease in defaults and,
the liquidity ratios’ target values. hence, a decrease in write-offs. As a decrease in write-offs leads
The results of the liquidity ratios’ distributions generally con- c. p. to an increase in balance sheet growth, it sets off the decrease
firm the results of the relative frequencies. For example, the mean in the net interest income resulting from the reduction of maturity
liquidity ratios’ values resulting from reaction rule 2 are on aver- transformation.
age higher than those resulting from reaction rule 1. The p-values The results regarding the liquidity ratios’ impact on equity
of the Mann–Whitney-test show that the differences are usu- return are summarized in Table 18. The table shows that the
ally significant at the 5%-level. Additionally, the mean liquidity results are in line with the results regarding the liquidity ratios’
ratios’ values tend to be higher (lower) within the interest rate impact on balance sheet growth. The results especially confirm
(macroeconomic) stress scenario as compared to the non-stress that equity return is significantly influenced by the reaction rules.
scenario. However, the rules again do not lead to an aligned impact on
The impact of the liquidity ratios on balance sheet growth is equity return. Instead, they lead to both higher and lower equity
presented in Table 17.27 The results indicate that balance sheet returns, depending on a bank’s size and the scenario. Again, the
growth is influenced by the scenario choice. While balance sheet macroeconomic stress scenario is accompanied by lower equity
growth rates decrease in the macroeconomic stress scenario, they returns, while the interest rate stress scenario comes with higher
increase in the interest rate stress scenario, which confirms the equity returns. Both effects are in line with the results on balance
results discussed regarding the liquidity ratios’ distributions. The sheet growth. However, as expected, the results indicate that the
Mann–Whitney-tests show that the growth rates that result from magnitude of a scenario’s influence on the equity return tends to
the usage of the reaction rules usually significantly differ at the be somewhat larger than that one on balance sheet growth. The
5%-level from those in the case without reaction rules. However, reason is that equity return is directly influenced by profits and
in contrast to the scenario choice, the influence of the liquidity losses, whereas balance sheet growth only loosely follows equity
ratios’ reaction rules on balance sheet growth is not unambiguous. growth.
The ambiguous impact can be traced back to offsetting effects that The liquidity ratios’ impact on bank default probability is
are associated with both reaction rules. Regarding reaction rule 1, summarized in Table 19. In this table, we distinguish between
the lower income from a larger portion of HQLA comes along with equity-related defaults, i.e., defaults due to a negative amount of
a decrease of defaults from fixed-income assets. Thus, lower net equity, denoted by PDEquity , and liquidity-related defaults, denoted
interest profits are accompanied by lower write-offs, whereas both by PDLiquidity . In detail, the bank defaults due to a liquidity-shortage
effects offset each other. Thus, the rule has no systematic impact when its cash amount is negative after it acquired its regular
on balance sheet growth. Considering reaction rule 2, the reduction amount of liabilities, the bank has no more collateral for repur-
of assets’ maturities comes with two effects. First, the reduction chase agreements and the bank has no more trading book assets
of the maturity transformation leads to a decrease in net inter- to sell. The results indicate that both equity- and liquidity-related
est income. However, the assets’ shorter residual maturities lead defaults matter, although the equity-driven default risk dominates
to fewer defaults, since each asset has less time to migrate into the liquidity-related default risk by far. Additionally, equity-driven
the default status. Additionally, each asset is reinvested via the default probabilities are remarkably higher in the macroeconomic
stress scenario than in the base scenario and interest rate stress
scenario. In contrast, the equity-driven default probabilities in the
27
Due to qualitative similar results, we only present the results on private banks in base scenario are only slightly higher than in the interest rate stress
the following. The results on savings and cooperative banks are available on request. scenario. Furthermore, the results show that banks are in general
G Model
Table 14
Banks’ reaction frequencies and liquidity ratios distributions in the non-stress scenario.
Reaction No reaction to liquidity ratios Reaction rule 1: investments in Reaction rule 2: shortening of
sovereign bonds the maturity transformation
Private banks
1. Frequency on reacting to the liquidity ratios (in %)
P (SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.88% 0.00% 0.00% 1.02% 0.06% 2.79% 0.58%
P (SLCR = 0 ∧ SNSFR = 1) 47.81% 12.88% 0.11% 86.00% 61.78% 0.09% 39.08% 36.57% 0.20%
P (SLCR = 1 ∧ SNSFR = 1) 52.18% 87.11% 2.85% 14.00% 38.22% 1.83% 7.02% 51.43% 1.21%
P (SLCR = 0 ∧ SNSFR = 0) 0.00% 0.00% 96.13% 0.00% 0.00% 97.06% 53.83% 9.21% 98.00%
2. Mean and standard deviation (LCR)

LCR 1.1722 1.0185 5.4234 1.3430 1.1980 5.8675 2.0715 1.1775 5.4647
LCR 0.2032 0.1275 2.6085 0.2103 0.1271 4.0050 0.5599 0.0737 5.2394
p-value (MW-Test, wR vs. R) – – – 0.0000 0.0000 0.2848 0.0000 0.0000 0.0000
p-value (MW-Test, R1 vs. R2) – – – – – – 0.0000 0.0000 0.0000
3. Mean and standard deviation (NSFR)

NSFR 1.0005 0.9613 1.1708 1.0115 0.9778 1.1711 1.0918 1.0690 1.1715
NSFR 0.0177 0.0163 0.0410 0.0187 0.0163 0.0387 0.0246 0.0351 0.0392
Savings banks
P (SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.20%
P (SLCR = 0 ∧ SNSFR = 1) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 5.65% 2.00% 3.42%
P (SLCR = 1 ∧ SNSFR = 1) 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 94.35% 97.98% 96.32%
P (SLCR = 0 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.01% 0.06%

LCR 0.6350 0.3111 0.3006 0.7197 0.3708 0.3499 1.0832 0.9211 1.0005
LCR 0.0408 0.0163 0.0179 0.0531 0.0366 0.0360 0.1015 0.1999 0.1831

NSFR 0.9621 0.9159 0.9103 0.9706 0.9235 0.9171 1.0284 1.0165 1.0341
NSFR 0.0169 0.0099 0.0096 0.0152 0.0108 0.0100 0.0252 0.0276 0.0248
Cooperative banks
P (SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.02% 0.24% 0.00% 12.61% 15.24% 2.75%
P (SLCR = 0 ∧ SNSFR = 1) 1.09% 0.00% 0.00% 6.01% 0.09% 0.55% 3.35% 1.53% 4.07%
P (SLCR = 1 ∧ SNSFR = 1) 98.58% 100.00% 100.00% 90.65% 99.46% 99.45% 74.05% 80.59% 91.57%
P (SLCR = 0 ∧ SNSFR = 0) 0.31% 0.00% 0.00% 3.33% 0.21% 0.00% 10.00% 2.64% 1.61%

LCR 0.6968 0.4615 0.4485 0.8085 0.5813 0.5849 1.0370 0.9069 0.8740
LCR 0.1463 0.0824 0.0845 0.2016 0.1413 0.1529 0.1800 0.2248 0.2345

NSFR 1.0136 0.9948 0.9654 1.0246 1.0062 0.9787 1.0651 1.0542 1.0223
NSFR 0.0293 0.0291 0.0253 0.0321 0.0325 0.0298 0.0334 0.0373 0.0410
Source: Own computation. All values are averages across N = 50 paths, i.e.,
50 min(Def (n),T ) LCR<1.2 50 min(Def (n),T )
P(SLCR = 1 ∧ SNSFR = 1) = (1/50) · (1/ min(Def (n), T ))· I (t, n) · I NSFR<1.1 (t, n) and LCR = (1/50) · (1/ min(Def (n), T )) · LCR(t, n),
n=1 t=1 n=1 t=1
where I LCR<1.2 (t, n) and I NSFR<1.1 (t, n) are binary variables whose value equals one, if LCR(t, n) < 1.2 and NSFR(t, n) < 1.1 holds on day t and path n, respectively, and
zero otherwise. Additionally, Def(n) denotes the day of default. ( · ) describes the distributions’ mean values and ( · ) denotes the empirical distributions’ standard deviations.
The p-values of the Mann–Whitney-Test (MW-Test) show the result of comparing the ratios’ values without reaction and with a respective reaction rule (wR vs. R) as well
as the comparison of the ratios’ values under reaction rule 1 and their values under reaction rule 2 (R1 vs. R2).
able to lower their default probability by reacting to the liquid- Regarding equity-related default risk, it seems that following the
ity ratios. However, this result is not significant, which is likely reaction rules also lowers the likelihood of observing equity-related
to be driven by the small number of N = 50 simulation paths.28 defaults. This result is also not statistically significant but may
result from the decrease of obligor defaults that comes along with
the utilization of both reaction rules. Since large write-offs are an
important driver of quick decreases in bank’s equity when asset
28
Due to the complexity of the balance sheet model, the large number of balance portfolios are not infinitely granular – as is the case in our model
sheet positions for each bank, and the 756 simulation steps per path, it takes several – the liquidity ratios also lead to a decrease in equity-related bank
hours to compute one simulation path. As we simulate nine different stylized banks defaults.
in three different scenarios (base scenario, macroeconomic stress and interest rate
stress) and three different reaction rules per scenario (no reaction, investing in a
Finally, we discuss the liquidity ratios’ impact on contractual
higher amount of sovereign bonds, shortening the maturity transformation), it was future net cash flows, whereby for simplicity non-maturity items
necessary to restrict the number of simulation paths to 50 to limit calculation time. are not taken into account. The results on this measure should
G Model
Table 15
Banks’ reaction frequencies and liquidity ratios distributions in the macroeconomic stress scenario.
Private banks
P(SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.40% 0.00% 0.00% 0.07% 0.00% 0.01% 0.79%
P (SLCR = 0 ∧ SNSFR = 1) 22.58% 7.98% 0.29% 24.25% 6.92% 0.75% 15.72% 13.50% 0.79%
P (SLCR = 1 ∧ SNSFR = 1) 77.27% 92.01% 0.33% 75.53% 93.08% 0.09% 75.61% 86.42% 0.54%
P (SLCR = 0 ∧ SNSFR = 0) 0.13% 0.00% 98.96% 0.22% 0.00% 99.10% 8.66% 0.08% 97.88%

LCR 0.8012 0.8352 9.6597 0.8161 0.8285 12.174 0.8689 0.9243 13.263
LCR 0.7189 0.1775 5.8611 0.7089 0.1626 8.2532 0.8272 0.1568 9.8326

NSFR 0.9724 0.8977 1.2027 0.9785 0.8921 1.2130 0.9854 0.9257 1.2106
NSFR 0.0453 0.0451 0.0458 0.0434 0.0437 0.0501 0.0543 0.0488 0.0513
Savings banks
P (SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
P (SLCR = 0 ∧ SNSFR = 1) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.34% 0.01% 0.09%
P (SLCR = 1 ∧ SNSFR = 1) 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 99.66% 99.99% 99.91%
P (SLCR = 0 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

LCR 0.5407 0.2850 0.3144 0.5530 0.2783 0.3275 0.8016 0.3579 0.5556
LCR 0.0983 0.0476 0.0573 0.0912 0.0492 0.0524 0.1282 0.0723 0.1182

NSFR 0.9119 0.8847 0.8943 0.9154 0.8799 0.9034 0.9461 0.9061 0.9518
NSFR 0.0426 0.0340 0.0348 0.0406 0.0362 0.0301 0.0341 0.0399 0.0345
Cooperative banks
P (SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
P (SLCR = 0 ∧ SNSFR = 1) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.02% 0.09%
P (SLCR = 1 ∧ SNSFR = 1) 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 99.98% 99.91%
P (SLCR = 0 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

LCR 0.3647 0.2914 0.2775 0.3620 0.2651 0.2602 0.3697 0.3438 0.3237
LCR 0.1190 0.0577 0.0458 0.1225 0.0633 0.0549 0.1348 0.0777 0.0740

NSFR 0.9088 0.9080 0.8810 0.9067 0.8885 0.8551 0.9064 0.9249 0.8878
NSFR 0.0442 0.0382 0.0357 0.0462 0.0438 0.0468 0.0481 0.0363 0.0402
50 min(Def (n),T ) 50 min(Def (n),T )
P(SLCR = 1 ∧ SNSFR = 1) = (1/50) · (1/ min(Def (n), T ))· I LCR<1.2 (t, n) · I NSFR<1.1 (t, n) and LCR = (1/50) · (1/ min(Def (n), T )) · LCR(t, n),
n=1 t=1 n=1 n=1
where I LCR<1.2 (t, n) and I NSFR<1.1 (t, n) are binary variables whose value equals one, if LCR(t, n) < 1.2 and NSFR(t, n) < 1.1 holds on day t and path n, respectively, and zero
otherwise. Additionally, Def(n) denotes the day of default. ( · ) describes the distributions’ mean values and ( · ) denotes the empirical distributions’ standard deviations. The
p-values of the Mann–Whitney-Test (MW-Test) show the result of comparing the ratios’ values without reaction and with a respective reaction rule (wR vs. R) as well as the
comparison of the ratios’ values under reaction rule 1 and their values under reaction rule 2 (R1 vs. R2).
give an indication of the reaction rules’ impact on the contrac- ence the maturities of balance sheet items, whereas reaction rule 2
tual maturity mismatch of cash flows. The results are shown in does.
Table 20. It shows the contractual future net cash inflows, NCF, Additionally, reaction rule 1 does not influence the relative fre-
of all fixed-income balance sheet items clustered in six differ- quency of contractual net cash outflows, P (NCF ( ) < 0), within
ent maturity buckets. The mean net cash inflows of each bucket each bucket, whereas reaction rule 2 does. Associated with the
show that maturity gaps appear, even without taking non-maturity risk horizon of one year of the NSFR, applying reaction rule 2
items into account. Moreover, these gaps cannot be closed using implies decreasing relative frequencies of negative contractual net
reaction rule 1, but, when at all, only using reaction rule 2. This cash flows within each liquidity bucket whose upper threshold is
is in line with expectation, since reaction rule 1 does not influ- within one year. However, this comes at the cost of an increase in
G Model
Table 16
Banks’ reaction frequencies and liquidity ratios distributions in the interest rate stress scenario.
Reaction No reaction to liquidity ratios Reaction rule 1: investments in Reaction rule 2: shortening of the
sovereign bonds maturity transformation
Private banks
P (SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.41% 0.00% 0.00% 0.44% 0.13% 2.92% 0.10%
P (SLCR = 0 ∧ SNSFR = 1) 32.12% 11.80% 0.04% 88.33% 73.97% 0.10% 38.75% 33.60% 0.36%
P (SLCR = 1 ∧ SNSFR = 1) 67.87% 88.19% 0.43% 11.67% 26.03% 0.30% 6.14% 52.97% 0.26%
P (SLCR = 0 ∧ SNSFR = 0) 0.00% 0.00% 99.10% 0.00% 0.00% 99.16% 54.98% 10.52% 99.28%

LCR 1.1535 1.0127 5.7583 1.3701 1.2582 5.9597 2.0433 1.1731 6.1223
LCR 0.1677 0.1276 2.0061 0.2013 0.1409 1.9836 0.5276 0.0653 2.2503

NSFR 0.9935 0.9583 1.1835 1.0065 0.9844 1.1850 1.0935 1.0680 1.1867
NSFR 0.0139 0.0185 0.0376 0.0146 0.0158 0.0377 0.0228 0.0357 0.0398
Savings banks
P (SLCR = 1 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.19% 0.80% 1.55%
P (SLCR = 0 ∧ SNSFR = 1) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 6.76% 3.28% 4.40%
P (SLCR = 1 ∧ SNSFR = 1) 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 92.89% 95.69% 93.54%
P (SLCR = 0 ∧ SNSFR = 0) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.16% 0.23% 0.51%

LCR 0.6473 0.3135 0.2914 0.7760 0.4020 0.3650 1.0859 0.9512 0.9988
LCR 0.0333 0.0139 0.0126 0.0831 0.0592 0.0438 0.1024 0.2073 0.1915

NSFR 0.9697 0.9209 0.9071 0.9827 0.9307 0.9185 1.0418 1.0366 1.0454
NSFR 0.0115 0.0088 0.0080 0.0124 0.0134 0.0087 0.0335 0.0371 0.0323
Cooperative banks
P (SLCR = 1 ∧ SNSFR = 0) 0.24% 1.84% 0.00% 0.15% 3.21% 0.00% 16.51% 23.74% 6.62%
P(SLCR = 0 ∧ SNSFR = 1) 4.63% 0.00% 0.00% 7.04% 0.16% 9.68% 2.49% 1.32% 5.20%
P(SLCR = 1 ∧ SNSFR = 1) 86.00% 98.05% 100.00% 70.11% 86.21% 89.27% 59.14% 69.86% 83.17%
P(SLCR = 0 ∧ SNSFR = 0) 9.11% 0.09% 0.00% 22.70% 10.43% 1.05% 21.86% 5.08% 5.00%

LCR 0.8292 0.5098 0.5133 1.0176 0.7262 0.7188 1.0740 0.9255 0.9290
LCR 0.2671 0.1273 0.1409 0.3758 0.2544 0.2727 0.2163 0.2496 0.2562

NSFR 1.0347 1.0076 0.9825 1.0510 1.0324 0.9982 1.0711 1.0595 1.0380
NSFR 0.0392 0.0357 0.0359 0.0439 0.0429 0.0430 0.0364 0.0416 0.0463
50 min(Def (n),T ) LCR<1.2 50 min(Def (n),T )
P(SLCR = 1 ∧ SNSFR = 1) = (1/50) · (1/ min(Def (n), T ))· I (t, n) · I NSFR<1.1 (t, n) and LCR = (1/50) · (1/ min(Def (n), T )) · LCR(t, n),
n=1 t=1 n=1 n=1
where I LCR<1.2 (t, n) and I NSFR<1.1 (t, n) are binary variables whose value equals one, if LCR(t, n) < 1.2 and NSFR(t, n) < 1.1 holds on day t and path n, respectively, and zero
otherwise. Additionally, Def(n) denotes the day of default. ( · ) describes the distributions’ mean values and ( · ) denotes the empirical distributions’ standard deviations. The
p-values of the Mann–Whitney-Test (MW-Test) show the result of comparing the ratios’ values without reaction and with a respective reaction rule (wR vs. R) as well as the
comparison of the ratios’ values under reaction rule 1 and their values under reaction rule 2 (R1 vs. R2).
the relative frequencies of negative net cash flows within buckets from the shortening of the balance sheet that is accompanied by a
whose lower limits are above one year. Furthermore, the scenario decrease in the portion of fixed-income liabilities. As this decrease
also seems to influence the values of P (NCF ( ) < 0). While the is primarily driven by a decrease of fixed-income liabilities with
interest rate stress scenario does not have a large impact on con- short maturities, short-term outflows decrease disproportionally.
tractual future net cash flows, the macroeconomic stress scenario This, in turn leads to the observed effect of lower frequencies
leads in tendency to remarkably lower frequencies of negative net of negative contractual net cash outflows in near future matu-
cash flows in near future maturity buckets. This effect not only rity buckets. As there is no shortening of the balance sheet in the
occurs when banks react to the liquidity ratios. Hence, the impact interest rate stress scenario, this effect cannot be observed in that
does not arise from the reaction rules. Instead, the effect results case.
G Model
Table 17
Annual balance sheet growth rates.
Private banks
Non-stress scenario
BS 0.0028 0.0189 −0.0255 0.0038 0.0164 −0.0184 0.0079 0.0210 −0.0177
BS 0.0407 0.0335 0.0476 0.0375 0.0320 0.0428 0.0350 0.0330 0.0395
Stress scenario 1: macroeconomic stress

BS −0.1248 −0.0600 −0.0472 −0.1212 −0.0622 −0.0550 −0.1231 −0.0714 −0.0628
BS 0.0943 0.0721 0.0485 0.0917 0.0811 0.0537 0.0970 0.0741 0.0575
Stress scenario 2: interest rate stress

BS 0.0520 0.0384 −0.0110 0.0521 0.0524 −0.0050 0.0461 0.0323 −0.0151
BS 0.0356 0.0405 0.0415 0.0360 0.0342 0.0383 0.0382 0.0351 0.0399
50 min(Def (n),T )
Source: Own computation. All values are rolling averages across N = 50 simulation paths, i.e., BS = (1/50) · (1/(min(Def (n), T ) − 251)) · (BS(t, n) − BS(t −
n=1 t=252
252, n))/BS(t − 252, n), where Def(n) denotes the day of default. BS describes the distributions’ mean values and BS denotes the distributions’ standard deviations. The
p-values of the Mann–Whitney-Test (MW-Test) show the result of comparing the balance sheet growth rates without reaction and with a respective reaction rule (wR vs. R)
as well as the comparison of the balance sheet growth rates under reaction rule 1 and the growth rates under reaction rule 2 (R1 vs. R2).
Table 18
Annual equity returns.
Private banks
Non-stress scenario
EQ −0.0017 0.0155 −0.0380 0.0009 0.0137 −0.0286 0.0017 0.0141 −0.0256
EQ 0.0506 0.0401 0.0659 0.0453 0.0384 0.0584 0.0478 0.0410 0.0521
p-Wert (MW-Test, wR vs. R) – – – 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
p-Wert (MW-Test, R1 vs. R2) – – – – – – 0.0000 0.0000 0.0000

EQ −0.1125 −0.0552 −0.0504 −0.1071 −0.0523 −0.0509 −0.1048 −0.0663 −0.0619
EQ 0.1199 0.0865 0.0772 0.1124 0.0923 0.0819 0.1162 0.0920 0.0871

EQ 0.0500 0.0336 −0.0159 0.0505 0.0497 −0.0061 0.0419 0.0277 −0.0187
EQ 0.0430 0.0497 0.0570 0.0424 0.0418 0.0491 0.0503 0.0463 0.0563
50 min(Def (n),T )
Source: Own computation. All values are rolling averages across N = 50 simulation paths, i.e. EQ = (1/50) · (1/(min(Def (n), T ) − 251)) · (EQ (t, n) − EQ (t −
n=1 t=252
252, n))/EQ (t − 252, n), where Def(n) denotes the day of default. EQ describes the distributions’ mean values and EQ denotes the distributions’ standard deviations. The
p-values of the Mann–Whitney-Test (MW-Test) show the result of comparing the equity growth rates without reaction and with a respective reaction rule (wR vs. R) as well
as the comparison of the equity growth rates under reaction rule 1 and the growth rates under reaction rule 2 (R1 vs. R2).
7. Model risk to the available liquidity of the simulated banks. To test the extent
of this type of model risk, on the one hand, we carried out a robust-
The results discussed above are model-driven and, thus, of ness check for which we used Ornstein–Uhlenbeck processes for
course subject to considerable model risk. As the modeling simulating the volumes of sight and demand deposits. As for this,
approach can influence the results to a large extent, we need to both processes are assumed to evolve independently of bank fun-
critically discuss the implications of our modeling approach. For damentals, disciplining effects do not occur. Accordingly, banks are
brevity reasons, we focus our discussion on two assumptions that expected to have more available funding when the bank fundamen-
we expect to be important drivers of the results. tals deteriorate (compared to the base case with market discipline
The first aspect that needs to be discussed is the approach to exerted by depositors). As a consequence, the simulation results did
model the evolution of demand and savings deposits, as German not exhibit a liquidity-related default of any bank in any scenario.
banks (in particular, out of the savings banks and cooperative banks On the other hand, for another robustness check, we intensified the
sector) heavily rely on this type of funding. Accordingly, using dif- disciplining effect by assuming that additionally there is a credit
ferent approaches may change the results, especially with regard rationing on the wholesale market whenever a bank’s rating is
G Model
Table 19
Default probabilities.
Non-stress scenario
1. Default probability of private banks

PDEquity 8.00% 6.00% 0.00% 4.00% 4.00% 0.00% 4.00% 6.00% 0.00%
PDLiquidity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 0.9502 0.9948 1.0000 0.9502 1.0000 1.0000
p-value (
2 -Test, R1 vs. R2) – – – – – – 1.0000 0.9948 1.0000
2. Default probability of savings banks

PDEquity 4.00% 8.00% 4.00% 4.00% 4.00% 4.00% 4.00% 2.00% 2.00%
PDLiquidity 0.00% 2.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 1.0000 0.8472 1.0000 1.0000 0.5855 0.9868
p-value (
2 -Test, R1 vs. R2) – – – – – – 1.0000 0.9868 0.9868
3. Default probability of cooperative banks

PDEquity 8.00% 10.00% 6.00% 8.00% 6.00% 4.00% 8.00% 4.00% 4.00%
PDLiquidity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 1.0000 0.9691 0.9948 1.0000 0.8472 0.9948
p-value (
2 -Test, R1 vs. R2) – – – – – – 1.0000 0.9948 1.0000

PDEquity 30.00% 20.00% 0.00% 24.00% 14.00% 0.00% 24.00% 18.00% 0.00%
PDLiquidity 0.00% 0.00% 4.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 0.9776 0.9588 0.7283 0.9776 0.9995 0.7283
p-value (
2 -Test, R1 vs. R2) – – – – – – 1.0000 0.9900 1.0000

PDEquity 14.00% 32.00% 18.00% 14.00% 20.00% 8.00% 6.00% 24.00% 10.00%
PDLiquidity 0.00% 6.00% 0.00% 0.00% 2.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 1.0000 0.5499 0.6971 0.7765 0.6824 0.8565
p-value (
2 -Test, R1 vs. R2) – – – – – – 0.7765 0.9996 0.9982

PDEquity 34.00% 26.00% 8.00% 32.00% 26.00% 8.00% 32.00% 12.00% 6.00%
PDLiquidity 0.00% 2.00% 0.00% 0.00% 0.00% 0.00% 0.00% 2.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 0.9997 0.9997 1.0000 0.9997 0.5656 0.9972
p-value (
2 -Test, R1 vs. R2) – – – – – – 1.0000 0.6899 0.9972

PDEquity 6.00% 6.00% 0.00% 4.00% 6.00% 0.00% 4.00% 4.00% 0.00%
PDLiquidity 0.00% 2.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 0.9948 0.9972 1.0000 0.9948 0.9502 1.0000
p-value (
2 -Test, R1 vs. R2) – – – – – – 1.0000 0.9948 1.0000

PDEquity 2.00% 4.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00%
PDLiquidity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 1.0000 0.9868 1.0000 1.0000 0.9868 1.0000
p-value (
2 -Test, R1 vs. R2) – – – – – – 1.0000 1.0000 1.0000

PDEquity 6.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 0.00%
PDLiquidity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
p-value (
2 -Test, wR vs. R) – – – 0.9948 1.0000 1.0000 0.9948 1.0000 0.7283
2
p-value (
-Test, R1 vs. R2) – – – – – – 1.0000 1.0000 0.7283
Source: Own computation. PDEquity denotes the equity- related default probability of the simulated bank. PDLiquidity describes the respective liquidity-related default probability.
The p-values of the
2 -Tests show the result of comparing the aggregate default probability without reaction and with a respective reaction rule (wR vs. R) as well as the
comparison of the aggregate default probability under reaction rule 1 and the probability under reaction rule 2 (R1 vs. R2).
speculative grade.29 In this case, the number of simulated liquidity- related defaults tends to increase. These observations show that
there is indeed model risk with respect to the funding assumptions.
Second, the results may also especially be sensitive to the
reinvestment rules and the associated assumption of missing
29
This effect mirrors the situation in the financial crisis 2007–2009 when many
funding markets were drying up. The results of the extended funding stress are
qualitatively similar to the base results and are thus not presented in here, but
available upon request. In our model, we technically connected this drying up with
the bank rating. In detail, we assumed that the bank is not able to roll over the to its rating. For calibrating the parameter ıSG , we rely on the results of Schmieder,
if it has a speculative grade rating. This mechanism
intended amount of liabilities,
banks
Hesse, Neudorfer, Puhr, and Schmitz (2014). The authors show that banks that
(1 − ıSG ) · D LI (t), k ≥5 were affected by the default of Lehman brothers could not roll over 10 to 30 %
Rationing
is given by DLI (t) = plan where ıSG ∈ (0, 1] and of their wholesale debt over a time horizon lasting one month. Since in our model
p lan
D LI (t), otherwise
p lan the rationing lasts at least one year, we orient ourselves at the lower threshold of
∈ R+
Rationing
DLI plan 0
. The variable ıSG denotes the share the bank is not able to roll over due Schmieder et al. (2014) and set ıSG = 0.1.
G Model
Table 20
Liquidity process review for private banks.
Non-stress scenario
1. Distribution of net cash flows in the first liquidity bucket ∈ [t + 1, t + 21]
P (NCF ( ) < 0) 41.39% 22.90% 35.17% 40.41% 23.86% 35.48% 7.75% 1.35% 35.64%
LB1 23.4613 5.4441 1.7344 23.8998 4.1873 1.8610 47.7101 12.6956 1.8422
LB1 145.7106 34.6576 7.7718 145.8025 38.9954 7.5647 173.0244 12.4606 7.2588
2. Distribution of net cash flows in the second liquidity bucket ∈ [t + 22, t + 63]
P (NCF ( ) < 0) 45.41% 29.78% 46.06% 45.49% 30.38% 47.20% 8.14% 1.41% 47.13%
LB2 −3.1888 0.3150 0.5258 −3.0940 0.3498 0.5205 12.5197 7.6256 0.5067
LB2 40.2504 6.8376 3.5700 40.4240 6.5165 3.5936 40.5364 6.8127 3.5700
3. Distribution of net cash flows in the third liquidity bucket ∈ [t + 64, t + 126]
P (NCF ( ) < 0) 26.02% 24.83% 23.61% 26.56% 25.68% 24.01% 7.36% 1.35% 23.85%
LB3 2.0549 0.4786 0.7783 2.0681 0.5059 0.7871 14.9119 8.0846 0.7812
LB3 33.9753 7.1874 3.8125 33.9932 6.8452 3.8459 35.2313 7.4186 3.8297
4. Distribution of net cash flows in the fourth liquidity bucket ∈ [t + 127, t + 252]
P (NCF ( ) < 0) 10.05% 8.02% 27.61% 10.31% 7.89% 28.32% 6.36% 3.20% 28.38%
LB4 6.8925 1.8088 0.7511 6.8642 1.8140 0.7473 12.4423 4.7406 0.7494
LB4 34.3341 2.9017 4.9675 34.3393 2.9205 4.9522 35.7525 4.8807 4.9751
5. Distribution of net cash flows in the fifth liquidity bucket ∈ [t + 253, t + 1260]
P (NCF ( ) < 0) 1.46% 3.12% 5.41% 1.49% 3.08% 5.48% 3.60% 12.50% 5.76%
LB5 11.7387 3.4830 0.6511 11.7247 3.4929 0.6550 9.9485 2.9624 0.6563
LB5 52.6863 39.7110 4.1112 52.5493 39.7234 4.0935 53.6712 39.4381 4.1207
6. Distribution of net cash flows in the sixth liquidity bucket ∈ [t + 1261, t + 2520]
P (NCF ( ) < 0) 4.33% 2.09% 5.04% 4.24% 2.12% 5.05% 9.48% 21.77% 5.42%
LB6 8.0304 2.6720 0.2598 7.9858 2.6575 0.2606 6.8781 1.7119 0.2609
LB6 39.3355 25.2702 1.4473 39.2227 25.2514 1.4503 39.5368 25.7716 1.4467

P (NCF ( ) < 0) 22.92% 48.04% 21.06% 24.99% 49.56% 17.83% 9.48% 8.81% 16.16%
LB1 −77.9806 −16.4100 1.5247 −72.7338 −20.2365 1.4488 −79.5481 −18.0435 1.2486
LB1 414.4972 83.6450 5.7873 388.7526 98.0947 5.5798 427.7886 102.9584 5.8163
P (NCF ( ) < 0) 11.64% 37.33% 24.53% 13.04% 36.67% 20.53% 5.07% 6.89% 18.17%
LB2 4.0139 0.0663 0.6388 4.0390 0.1070 0.6601 5.8130 1.9902 0.6464
LB2 34.0624 5.4476 3.4102 34.3418 5.3689 3.3746 34.1139 4.8260 3.2797
P (NCF ( ) < 0) 5.06% 29.15% 13.15% 5.57% 28.73% 11.37% 4.26% 7.15% 10.74%
LB3 6.1621 0.2896 0.7079 6.2474 0.3169 0.7041 7.2877 2.0414 0.6792
LB3 27.4904 5.9210 3.7062 28.1207 5.8548 3.6968 28.2857 5.3116 3.6004
P (NCF ( ) < 0) 3.13% 13.95% 12.86% 3.28% 13.55% 10.47% 3.05% 9.17% 9.83%
LB4 7.2232 1.2704 0.7130 7.3156 1.2554 0.7224 7.8413 1.7303 0.7021
LB4 30.0027 2.8916 4.8107 30.6535 2.9282 4.8685 31.2649 3.1607 4.7307
P (NCF ( ) < 0) 1.71% 2.61% 3.17% 1.70% 2.44% 2.90% 2.37% 7.58% 2.88%
LB5 9.1559 3.0544 0.5540 9.1640 3.0575 0.5345 8.9128 2.9100 0.5311
LB5 51.7265 39.6198 3.9883 51.9788 39.6714 3.9696 52.5226 39.6333 3.9360
P (NCF ( ) < 0) 1.28% 0.68% 1.55% 1.28% 0.71% 1.38% 5.37% 12.63% 1.28%
LB6 5.5431 2.0735 0.2380 5.5256 2.0100 0.2349 5.2848 1.6953 0.2333
LB6 39.2758 25.2354 1.3845 39.0034 25.1920 1.3643 39.1327 25.2813 1.3595

P (NCF ( ) < 0) 45.78% 22.10% 29.89% 45.56% 23.32% 29.61% 8.53% 1.34% 28.72%
LB1 25.5336 3.6483 2.1825 24.6606 5.4496 2.2432 51.0057 11.8959 2.1573
LB1 142.7433 44.3459 7.1848 144.4035 36.4257 7.0692 172.8038 17.3025 6.9338
G Model
Table 20 (Continued)
P (NCF ( ) < 0) 50.24% 29.79% 40.45% 49.98% 31.39% 40.66% 9.08% 1.37% 38.78%
LB2 −5.2235 0.2506 0.6021 −5.1983 0.1960 0.5983 13.1109 7.6829 0.6061
LB2 42.5739 7.3161 3.5916 42.1154 7.1303 3.5975 41.1760 6.7355 3.5720
P (NCF ( ) < 0) 30.54% 24.74% 18.99% 30.06% 26.71% 18.86% 8.15% 1.36% 18.38%
LB3 0.9407 0.4265 0.8085 0.9670 0.3572 0.8142 15.9684 8.1707 0.8001
LB3 35.6470 7.7076 3.8344 35.5502 7.5754 3.8575 35.9551 7.3331 3.8186
P (NCF ( ) < 0) 11.91% 6.79% 21.94% 11.73% 6.83% 21.99% 6.84% 3.56% 20.83%
LB4 6.9935 1.9576 0.7766 7.0054 1.9758 0.7795 13.5448 4.7687 0.7710
LB4 35.3057 2.9989 5.0009 35.3992 3.0566 5.0124 36.1799 4.8860 4.9836
P (NCF ( ) < 0) 1.48% 3.25% 4.01% 1.49% 3.15% 3.96% 3.96% 13.29% 3.88%
LB5 12.5686 3.6221 0.6479 12.6031 3.6607 0.6464 10.2425 2.9862 0.6419
LB5 52.7571 39.7124 4.1644 52.7914 39.7430 4.1412 53.6987 39.6909 4.1550
P (NCF ( ) < 0) 5.67% 2.85% 2.36% 5.72% 3.08% 2.30% 10.04% 22.03% 2.16%
LB6 8.4621 2.7796 0.2604 8.4656 2.8037 0.2603 7.1718 1.7260 0.2587
LB6 39.5665 25.3426 1.4467 39.4917 25.3517 1.4545 39.7034 25.7987 1.4460
Source: Own computation. ( · ) is the average of the expected contractual future cash flows within each liquidity bucket across N = 50 simulation paths, i.e., for example,
50 min(Def (n),T ) t+21
LB1 = (1/50) · (1/ min(Def (n), T )) · (1/21) · NCF( ) with NCF( ) = CFa ( ) − CFp ( ). P (NCF( ) < 0) denotes the average relative number
n=1 t=1 =t+1 a p
of days with contractual cash outflows within the respective maturity bucket. (·) is the average of the standard deviations of the contractual future cash flows within each
liquidity bucket across N = 50 simulation paths.
investment restrictions, because this part of the model determines target ratios quicker compared to a separate usage of either reac-
the bank behavior throughout the simulation. For example, the tion rule 1 or reaction rule 2. Fourth, the assumption that banking
reinvestment rule setup implies a mechanical behavior that does book items do not change their accounting value unless there is a
not adjust to different environment situations, e.g., different stress default of the issuer could be released. For example, allowing for
scenarios. The assumption of missing investment restrictions also impairments would cause intermediate losses for the bank which
influences the banks’ ability to steer the liquidity ratios. This can in turn would strengthen the disciplining effect exerted by depos-
be easily shown for the LCR. Due to the assumption of missing itors. Finally, fifth, in a more comprehensive approach, we could
investment restrictions, the bank can always buy HQLA to an extent broaden the bank-individual perspective that we employed by a
that meets its demand. Changing this assumption will of course network perspective. In a banking network, the behavior and per-
change the effectiveness of the reaction rules. For example, in a sit- formance of one bank can influence the behavior and performance
uation with strong HQLA shortage, i.e., no supply of HQLA, banks of other banks (e.g., by informational contagion, interbank expo-
would not be able to buy this type of asset. Herein, reaction rule sures or fire sales). This connectedness can in turn influence the
1 would be ineffective, i.e., banks could not increase the LCR by impact of regulatory liquidity ratio restrictions and the efficiency
using this reaction rule. However, there would be no impact on of reaction rules.
reaction rule 2. This rule would still be effective in reaching the Despite the discussed models risks and potential model exten-
liquidity ratios’ target values as it aims to decrease the net cash sions, the presented results may also have policy implications. First,
outflows in near future maturity buckets, thereby increase the LCR our results show that liquidity- related defaults are unlikely in
in total. absence of strong funding stress. This result holds even without
central bank actions. This finding highlights the importance of a liq-
8. Future research and policy implications uidity regulation that is designed to ensure bank liquidity in stress
situations. Second, we argue that the introduction of both LCR and
As indicated above, our model leaves space for future research. NSFR is generally useful achieving this goal. Our results indicate
First, the process for the risk-free short rate could be changed that the reaction rules lead to a decrease of default probabilities
to better fit the currently observed partly negative interest rate across all types of banks. Although these results are (probably due
term structure. This change could have an impact on bank prof- to the small number of N = 50 simulation paths) not significant, the
its. Second, our model is open for different reinvestment rules. For default probabilities indicate that both reaction rules seem to alle-
example, it would be interesting to use a dynamic reinvestment viate default risk. Third, the results do not indicate adverse effects
rule that adjusts the balance sheet structure to the macroeco- from the liquidity ratios’ introduction, as neither balance sheet
nomic environment. In economic upturns, the rule could put a growth nor equity returns are unambiguously influenced by the
higher weight on balance sheet items that drive the upturn and reaction rules. This result is in line with Banerjee and Mio (2015)
vice versa. However, as there is only sparse empirical literature who do not find an impact from the LCR’s introduction on balance
on bank balance sheet behavior, a reasonable modeling approach sheet length. Furthermore, our results may help to understand the
requires additional empirical research on this topic. Third, and in finding from Schmitt and Schmaltz (2016). The authors show that
line with this, the reaction rules could be changed to assess dif- an introduction of the NSFR leads to a marginal decrease of equity
ferent strategies to increase the liquidity ratios’ values. The easiest growth on average. Following our results, the magnitude of this
way would be to use a combination of the presented reaction rules finding could be a result of the ambiguous impact of the liquidity
1 and 2. In this case, we would expect that banks c. p. reach the ratios’ introduction on equity growth. In detail, our results show
G Model
that the liquidity ratios’ introduction may not only lead to decreas- The change in the short-rate r(t) within the CIR-approach can be
ing equity growth rates, but also to increasing equity growth rates, represented in discrete form as
depending on a bank’s sector affiliation, its size and the scenario.
r (t) − r (t − 1) = r · (r − r (t − 1)) /252

9. Conclusion + r · r (t − 1) · Xr (t) · 1/252 (5)
In this paper, we construct a balance sheet simulation model i.i.d.

with flexible step sizes and a flexible simulation horizon. The model where r , r , r ∈ R+ and Xr (t) ∼ N(0, 1). Herein, Xr is called
can be characterized as bottom-up model because it is based on risk interest rate factor as it drives the evolution of the short-rate. r
factors that drive the evolution of all balance sheet items together. denotes the long-run mean of the short rate and r describes its
We calibrate the model for different types of German banks by using instantaneous volatility. The parameter r is the mean reversion
private data from Deutsche Bundesbank. In detail, we construct parameter and describes how fast r(t) reverts to its long-run mean.
nine different stylized balance sheets for each banking sector in To speed up the computations, this discrete-time approximation of
Germany, i.e., savings banks, cooperative banks and private banks, the CIR-process was used for the simulation of the risk-free short
and separate between large, medium-sized, and small institutions rate over time.31 Based upon the formulas in De Munnik (1996, pp.
in each sector. The data also enables us to derive detailed balance 78-79), the simulated short rates were used to compute the term
sheet information regarding the distribution of assets across obligor structure of spot rates at each time t.
types, loan size concentration, and portfolio granularity. The solution of the mean-reverting Ornstein–Uhlenbeck pro-
The results on model calibration show that the initial values cesses that we use for modeling the rating-specific credit spreads
of LCR and NSFR are broadly in line with empirical observations, can be represented as32
indicating that the constructed balance sheets come with realistic
sk (t) = k (1 − e−k /252 ) + e−k /252 · sk (t − 1)
values of both liquidity ratios. Simulation results further show that
the introduction of LCR and NSFR has no unambiguous impact on =E[sk (t)|sk (t−1)]
equity return nor on balance sheet growth. Moreover, it is more
difficult to comply with the ratios’ thresholds in stress situations. (1 − e−2 · k /252 )
+k · · εk (t) (6)
Regarding the ratios’ impact on contractual future cash flows, our 2 · k
results further show that a shortening of maturity transformation
√
can lead to a closing of liquidity gaps while a simple asset substi- = Var[sk (t)]
tution strategy does not. In line with this, a shortening of maturity

transformation also decreases the number of days with negative i.i.d.
where k , k , k ∈ R+ and εk (t) ∼ N (0, 1). Herein, k denotes the
contractual net cash flows within one year. However, this comes
long-run rating-specific mean of the process and k describes the
at the cost of higher frequencies of negative net cash flows for
respective volatility. k is the mean reversion parameter.
maturities above one year.
The asset return Rf b that drives the rating migration of an issuer
f b is given by
Appendix A. Technical model implementation
Rf b (t) = 2 · Y (t) +
b − r,b r,b · Xr (t) + 1 − b · εf b (t) (7)
A.1 Fixed-income items
i.i.d.
Let Nf be the nominal value of any fixed-income item in our where Xr (t), Y (t), εf b (t) ∼ N (0, 1), b , r,b ∈ [0, 1] and b ∈

model, then its present value Vf in t is given by banks, others . b and r,b denote the industry-specific pairwise
correlation of asset returns and the industry-specific correlation

mf
CFf ( ) between the risk-free short rate and the asset return of an obligor,
Vf t, r, s, k, mf = (3) respectively. Y is a latent macroeconomic risk factor. While Y and Xr
(1 + r (t, − t) + sk (t) + g)( −t)/252
=t affect the asset returns of all issuers in industry b, each asset return
also has an idiosyncratic component which is given by εf b .33
with
Given his asset return over a specific time period, an issuer
⎧ migrates from k into another rating class k* , if his asset return is
⎪ C ( ) · Nf , < mf ∧ (m − ) mod 252 = 0
⎨ f higher or lower than some return thresholds Bk,k c
∗ . These thresh-
CFf ( ) = Cf ( ) · Nf + Nf , = mf (4) olds are derived from industry-specific transition matrices and are
⎪
⎩
0, otherwise given by
8

where Vf , Cf , CFf , g, r ∈ R+ , Nf ∈ R+ , sk ∈ R, k ∈ 1, 2, ..., 7 , c
=˚ −1
qck,l
0 Bk,k ∗ (t, t + 1) (8)
t, , mf ∈ N0 and , mf ≥ t. CFf ( ) denotes the item’s specific cash
l=k∗
flow, which consists of periodical coupon payments Cf ( ) · Nf and
the repayment of the item’s principal Nf . The maturity-adjusted where ˚−1 denotes the inverse of the cumulative dis-
risk-free spot rate for a maturity of − t at time t is r (t, − t). sk (t) tribution function of the standard normal distribution and
denotes the item’s specific credit spread at time t (assumed to be
not maturity-adjusted), and g is the premium to compensate the
owner of the item for holding subordinated debt. k ∈ {1, 2, . . ., 7}30 31
Whenever negative short-rates occur, we set it equal to 1 × 10−10 . In particular,
indicates the rating of the issuer of an item. this happens in the interest rate stress scenario.
32
See Phillips and Yu (2009).
33
Note that it would also be possible to construct asset class-specific returns by
adding or altering risk factors, or by using asset class-specific correlation values.
30
Note that k = 1 denotes the best rating grade, k = 7 denotes the second worst However, for the ease of simplicity, we stick to the above representation of asset
rating grade, i.e., the rating grade before default. returns.
G Model
qck,l (t, t + 1) constitute the one-day migration probabili- with

ties of the industry-specific migration matrices. Herein,
c denotes a more detailed industry differentiation, i.e.,
c ∈ {banks, corporates and public authorities} and, thus, D (t) = ˇD0 · D (t − 1)
k* ⎛
allows for a more detailed rating migration
∗
behavior. Moreover,

F p
encompasses the default state, i.e., k ∈ 1, 2, ..., 8 .
c occurs, an obligor f gets the best rating. +ˇD1 · ⎝ Cf p (t − 1) · Nf p (t − 1) + ZSD (t − 1)
Whenever Rf b (t) > Bk,1
f p =1
c
In contrast, if Rf b (t) ≤ Bk,8 holds, the obligor defaults. Accordingly,
the obligor migrates to a rating class 2 ≤ k∗ ≤ 7, when
∞
c c
its return is + ZTD (t − 1, − t + 1) /LI (t − 1)
between the related return thresholds Bk,k ∗ , Bk,k∗ +1 .
=t−1
Whenever an obligor defaults, the absolute loss Lossf c and the
+ˇD2 · BS (t − 1)
recovered fraction of the asset’s nominal value Recf c are given by
(15)
+ˇD3 · EQ (t − 1)
Lossf c = LGDf c · Nf c (9) ⎛ ⎞

F a
and +ˇD4 · ⎝ Lossf a (t − 1) · I Def · I Credit ⎠ /

Recf c = Nf c − Lossf c f a =1
(10) ⎛ ⎞

F a
where Lossf c , Recf c ∈ R+

i.i.d.
, LGDf c ∼ beta(˛c , ˇc ) and ˛c , ˇc ∈ ⎝ Nf a (t − 1) · I
Def
· I Credit ⎠
0
R+ . In line with this, LGDf c describes the industry- and obligor- f a =1
specific loss-given-default. +ˇD5 · PLC (t − 1) /BS (t − 1)
Following the ideas of Merton (1974), we assume the one-year
default probability of the modeled bank itself to be given by

where D ∈ DD, SD , D , EQ , BS , ˇD0 , ˇD1 , ˇD2 , ˇD3 , ˇD4 , ˇD5 ∈
ln DB(t)
BS(t)
− (BS − 1
2
2 )
· BS
PD(t, t + 252) = ˚ (11) R and I K ∈ 0, 1 . The variable D describes the deposits growth
2
BS rate. The log-growth rates of the balance sheet and equity are given
by BS and EQ , respectively. Moreover, I Credit is a binary variable
where BS(t), DB(t) ∈ R+ 0
, BS ∈ R+ , and BS ∈ R. Herein, BS (t) whose value equals one, if a balance sheet item is a loan, and zero
denotes the balance sheet volume at time t, and DB(t) describes the otherwise.
total amount of debt at time t, which we employ as proxy for the at Additionally, the deposit rate e(t) is given by
time t unknown future debt volume DB(t + 252) that we actually
would need in the above formula. BS and BS indicate the expected
growth rate and the volatility of the growth rate of the balance sheet ⎧
⎪
⎨ aD + bD + cD · r (t) , r (t) ≥ uD
volume, respectively. Finally, ˚ is the cumulative distribution func-
tion of the standard normal distribution. The time-averaged default e (t) = (16)
⎪
⎩ aD + (bD + cD · uD ) · r (t) , r (t) < uD
probability PD(t) of the bank at time t that we use for determining
uD
the rating of the bank at time t is given by the average of the above
one-year default probabilities over the last 252 days:
⎧ where aD , bD , cD , uD ∈ R+ and r(t) is the risk-free short rate
⎪
⎨ 1
t
· PD(i, i + 252), t mod 252 = 0 modeled with the CIR- approach.

PD(t) = 252 (12)
⎪
⎩ i=t−251
PD(t − 1), otherwise.
An adjustment of the bank’s rating based on PD(t) is done once A.4 Off-balance sheet items
a year.
The undrawn amount UNcf,k (t) of each credit facility cf is given
A.2 Non-fixed-income items by
Let Nnf = Vnf (0) the value of a non-fixed income item at which
it initially entered the balance sheet. Its market value at time t is UNcf,k (t) = (1 − uk (t)) · Ncf (17)
assumed to be given by

(nf − 1 · 2 )/252+nf · 1 ·ε (t)
Vnf (t) = Vnf (t − 1) · e 2 nf 252 nf
(13) where Ncf , UNcf,k (t) ∈ R+0
and uk (t) ∈ [0, 1]. uk (t) describes the
average, rating-dependent share of the facility that each obligor
i.i.d. with rating k draws at time t. The maximum facility amount is given
where εnf (t) ∼ N(0, 1).
by Ncf . Additionally, the drawn amount of any obligors’ facility at
the default event is given by
A.3 Deposits
Let NDD be the total amount of demand deposits and NSD be the
UNcf,8 (t) = 1 − uk (t) − uk,8 · Ncf (18)
total amount of savings deposits, then, following Domikowsky et al.
(2015), both amounts are assumed to evolve according to
ND (t) = ND (t − 1) · D (t) (14) where uk,8 ∈ [0, 1] and uk + uk,8 ≤ 1.
G Model

a a
A.5 Profit and loss calculation F F
Def
CFC(t) = I · CFf a (t) + I Def · Recf a (t)
The profit and loss calculation PLC(t) for a single day t is given f a =1 f a =1
by
F p

F p
Def
− I · CFf p (t) − I Def · I TB · Recf p (t) (24)

F a F a
Def Def
PLC(t) = I f a · Cf a · Nf a (t) + If a · IfTB
a · Vf a (t) + Vnf TB (t) f p =1 f p =1
f a =1 f a =1
CFac
CFac
+NDD (t) + NSD (t) − uk · Ncfac − I Def · uk,8 · Ncfac.

Def
Fa
Def
Fa
− If a · Lossf a (t) − If a · IfTB
a · (Vf a (t) − Nf a (t)) cfac=1 cfac=1
f a =1 f a =1 The evolution of the cash amount CA is not only affected by

Def
Fp
Def
Fp
the cash flow calculation but also by the respective tax provisions.
− I f p · Cf p · Nf p (t) − I f p · IfTB
p · Vf p (t) − Vnf TB (t) Hence, the cash account evolves in each period t according to
f p =1 f p =1
CA (t) = CA (t − 1) + CFC (t) − Tax (t) (25)
Def
Fp Def
Fp
+ If p · IfTB
p · Lossf p (t) + If p · IfTB
p · (Vf p (t) − Nf p (t)) where CFC(t) ∈ R and CFC (0) = 0.
f p =1 f p =1

∞
A.7 Correlations
−ZSD (t) − ZTD (t, − t).
=t The structure of dependencies between the normally dis-
(19)
tributed random variables that drive the various stochastic
processes can be summarized in a lower triangular part of a
Moreover, the tax provision TP(·) , which develops according to thirteen-dimensional correlation matrix, which is given by
a fixed tax rate TR and the banks’ cumulative profits Profit, is given ⎛ ⎞
1
by
⎜ Y,Xr 1 ⎟
⎜ ⎟
TPa (t) = TPp (t) = Tax (t) (20) ⎜ ⎟ (26)
⎜ .. .. ⎟
with ⎝ . . ⎠
Y,εSD ··· εDD ,εSD 1
Tax (t) = max (0, TR · Profit (t)) (21)
and where (·) denote the respective pairwise correlations.34

0, t mod 252 = 0
Profit (t) = (22) A.8 Reinvestment rules
Profit (t − 1) + PLC (t) , otherwise
where TR ∈ [0, 1], TPa , TPp , Tax ∈ R+ , Profit(t), PLC(t) ∈ R and The target (equilibrium) equity ratio is given by EQ (0) /BS (0).
0
PLC (0) = TPa (0) = TPp (0) = 0. In Eq. (20), TPa is the provision built Hence, the amount of liabilities DLI plan (t) required at time t is cal-
on the asset side of the balance sheet, while TPp denotes the pro- culated as
EQ
vision built on the liabilities side of the balance sheet. Both, TPa (t)
DLI plan (t) = max · BS (0) − BS (t) , 0 (27)
and TPp are managed on separate balance sheet accounts. Thus, EQ (0)
after considering tax-provisions, the equity evolves in each period
where DLI plan (t) ∈ R+
0
.
according to
The bank borrows on the types of liabilities according to
EQ (t) = EQ (t − 1) + PLC(t) − Tax(t). (23)
D̃lit (t)
Dlit (t) = · DLI plan (t) (28)
A.6 Cash flow calculation
LIT
D̃lit (t)
The cash account calculation CFC(t) for a single day t is given by lit=1
with
⎛ ⎞
⎜ ⎟
⎜ ⎟
⎜ P(0) ⎟
⎜ ⎟
⎜ B (0) · I lit
LIT P(t) ⎟
⎜ p ⎟
⎜ p=1
P(t)
⎟
⎜
D̃lit (t) = max ⎜ · lit
Bp (t) · I + DLI plan (t) − Bp (t) · I lit
, 0⎟ (29)
⎟
⎜ LIT P(0)
⎟
⎜ Bp (0) · I lit
lit=1 p=1

p=1
⎟
⎜ ⎟
⎜ lit=1 p=1 ⎟
⎜ ⎟
⎝ sum of aggregate amounts of aggregate amount of ⎠
each lit including the amount lit in t
proportion of lit in t=0
from new borrowings in t
34
Due to the resulting interdependencies, it is necessary to use conditional normal
distributions of all variables when stressing single variables. For details, see, e.g.,
Greene (2012).
G Model

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QUAECO-1235; No. of Pages 24 ARTICLE IN PRESS

Contents lists available at ScienceDirect

The Quarterly Review of Economics and Finance

The impact of the Basel III liquidity ratios on banks:

4. Dynamic balance sheet model 4

Fig. 1. Balance sheet structure and section referencing.

Instead of assuming a stochastic process, we rely on an assump- 4.2. Reinvestment rules

Table 1 and liabilities maturing within 12 months. In detail, this database

Fig. 2. Initial balance sheet.

Initial rating Rating 1 year later

AAA AA A BBB BB B CCC-C D NR

Initial rating Rating 1 year later

AAA AA A BBB BB B CCC-C D NR

Initial rating Rating 1 year later

AAA AA A BBB BB B CCC-C D NR

(c) Public authorities

Process Parameter Sector Parameter

CIR-process 0.2552 0.0028 0.0331 0.5 Banks 0.2822 0.3450

AAA (k = 1) 0.0038 0.0013 nf nf

Initial rating Rating 1 day later

Initial rating Rating 1 day later

Initial rating Rating 1 day later

by ourselves. Own estimations are based on data spanning the Table 10

Source: Own computation based on data from Deutsche Bundesbank.

Macr. factor Int. rate factor Credit spreads Stocks Deposits

(a) Overall valid correlations

Sector Private banks Savings banks Cooperative banks

(b) Bank-speciﬁc correlations

Sector Liquidity ratio

(a) Initial balance sheet Private banks

Group 2 (other banks) max > 4.0 max ≈ 5.29

Source: (a) Own computation; (b) BCBS (2014b), Table 20.

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

2. Mean and standard deviation (LCR)

3. Mean and standard deviation (NSFR)

Stress scenario 1: macroeconomic stress

Stress scenario 2: interest rate stress

Stress scenario 1: macroeconomic stress

Stress scenario 2: interest rate stress

1. Default probability of private banks

2. Default probability of savings banks

3. Default probability of cooperative banks

Stress scenario 1: macroeconomic stress

1. Default probability of private banks

2. Default probability of savings banks

3. Default probability of cooperative banks

Stress scenario 2: interest rate stress

+NDD (t) + NSD (t) − uk · Ncfac − I Def · uk,8 · Ncfac.

and where (·) denote the respective pairwise correlations.34