Work

Enough liquidity with enough capital—and vice versa?

Year: 2026

Type: article

Abstract: We study the interplay of capital and liquidity regulation, focusing on future funding risks. Our model features a banking sector with access to long-term illiquid investment opportunities, financed through short-term debt and equity issuance. The reliance on refinancing midway through the investment cycle is risky, as future investors may withhold funding if return prospects deteriorate. We derive two main findings. First, when liquidity shortfalls are rooted in concerns about future solvency, optimal capital regulation directly addresses the underlying fragility and renders liquidity regulation redundant. Second, in the absence of sufficient capital buffers, liquidity regulation can act as a partial substitute by stabilizing the bank’s asset side and improving resilience to shocks.

Source: Journal of Financial Stability

DOI: 10.1016/j.jfs.2026.101513

Authors: Hans Gersbach, Hans Haller, Sebastian Zelzner

Institutions: ETH Zurich, Virginia Tech

Language: English

Topic: Banking stability, regulation, efficiency

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: hybrid

Estimated APC paid: $3,470

Funder: Eidgenössische Technische Hochschule Zürich