Tracing the Liquidity Effects on Bank Stability in Barbados

This paper provides a micro-economic approach to evaluating bank stability in the face of adverse liquidity conditions. Specifically, it examines the potential for systemic risk as a result of liquidity shocks on each bank. According to Nier et al., (2008) systemic risk results when the failure of multiple banks imposes significant costs on the entire economy. This assessment is done by tracing the liquidity effect across institutions based on the degree of exposure among commercial banks. In this study, a bank with an after-shock capital adequacy ratio (CAR) less than 8 percent is assumed to require additional capital. In addition, systemic risk rises when the CAR of the entire banking sector converges to the 8 percent threshold. Overall, the results suggest that banks in Barbados are well capitalised and are able to withstand significant liquidity shocks. In addition, the study found that banks can be ranked in terms of systemic importance. Consequently, the second-round effects that result from systemically important banks tend to have large impacts with significant implications for bank stability