Other things being equal, a firm is more robust to economic shocks the higher its equity is relative to its total assets. That reduces the risk that the firm will fail. It also reduces the probability that the firm’s bankers will suffer losses on their lending to the firm. Hence, a high solvency ratio has a positive impact on financial stability.
A high solvency ratio also gives the individual firm greater flexibility when choosing between alternative sources of funding and greater certainty of obtaining the desired funding. An analysis by Danmarks Nationalbank shows that since the financial crisis erupted, loan capital in the Danish banking system has to a large extent flowed to the soundest, most profitable and productive firms.