NY Fed Economists Propose New Measure of Bank Solvency
Commentary by Sebastian Souchet
Federal Reserve Bank of New York economists proposed a new framework for assessing bank solvency.
In its Liberty Street Economics blog, the economists explained that many existing solvency metrics are backward-looking and incomplete. The authors argued that traditional solvency metrics are insufficient because they do not fully capture changes in value from interest rate movements or the critical interaction between a bank's solvency and its liquidity risk, such as a run on deposits.
Based on their academic research, the economists proposed an "alternative measure of bank solvency based on estimates of the present values of assets, liabilities, and operating expenses". They described the new measure - "Economic Capital" ("EC") - as incorporating "changes in bank value due to movements in interest rates and credit spreads as well as the changes in value from credit losses recognized in traditional solvency measures." They said that EC "also incorporates assumptions about the timing of payments and the stability of deposits."
The economists emphasized that the new approach provides a fuller picture of bank health than traditional accounting-based metrics and noted that the EC framework captured solvency deterioration during the Global Financial Crisis that conventional measures understated. The economists found that under the baseline EC framework, which assumes stable funding and retention of uninsured deposits, industry solvency has strengthened since the global financial crisis, with capital levels averaging above 20 percent of assets. The economists cautioned that in a stressed run EC scenario, where uninsured deposits are replaced with more expensive funding, solvency has not improved materially since the crisis. They warned that this reflects banks’ growing reliance on uninsured deposits and demonstrates that solvency risks persist if funding stress emerges.
Commentary
The development of the concept of "economic capital" as an alternative metric for evaluating bank solvency is very likely a response to the March 2023 bank failures. Notably, the researchers' related March 2025 report states that the stressed EC metric, when applied to four banks that failed in March 2023, identifies such "banks' exposure to funding risk relative to the rest of the banking industry, at least five years ahead of the March 2023 episode" (p. 35) (emphasis added).
Perhaps the core takeaway from the researchers' stressed EC analysis is the following: "[P]ost-crisis changes in prudential regulation aimed at larger banks do not appear to have resulted in materially lower solvency risk for these firms, either over time or relative to smaller banks." As the federal banking regulators actively consider reforming bank capital regulations, it may be prudent to assess the impact of such regulatory reforms by, among other things, utilizing the stressed EC metric.