Impact of liquidity and solvency risk factors on variations in efficiency of US banks

Purpose This paper evaluates the importance of both liquidity and solvency risk factors on variations in efficiency measures of US commercial and domestic banks from 2005 to 2017. Design/methodology/approach The analysis is conducted using the true random effect stochastic cost model to examine the role of both liquidity and solvency risk factors. To this end, the author uses the exponential stochastic cost function and adds new variables, including bank size, crisis as an indicator of the financial crisis and the Dodd-Frank Act and Basel II Accord as regulatory dummies. Findings The results show that both liquidity and solvency risk factors positively affect the variance of cost inefficiency measures and thus have negative impact on the cost efficiency measures. In addition, banks increased the cost of financial intermediation during the financial crisis, whereas regulatory factors of Basel II Accord and Dodd-Frank Act play a crucial role in explaining the cost efficiency measures. Originality/value These results are the first to quantify the impact of both liquidity and solvency on the variations in cost efficiency measures.