This paper examines liquidity risk in a system of interconnected financial institutions under regulatory solvency constraints and mark-to-market accounting. When market demand for illiquid assets is not perfectly elastic, sales by distressed institutions can depress asset prices, leading to further sales and price declines. Contagious failures can result from small shocks, and the paper investigates the theoretical basis for these failures through simulations. Liquidity requirements can be as effective as capital requirements in preventing contagious failures. The paper constructs a model with two channels of contagion: direct balance sheet interlinkages and contagion via asset price changes. Changes in asset prices can interact with solvency requirements or internal risk controls to generate amplified endogenous responses. An initial shock that reduces a firm's balance sheet value can lead to asset disposals, which may further depress prices and trigger more sales. This process can amplify the initial shock, leading to systemic risk. The paper argues that asset price contagion alone does not justify opposing prudential regulations or transparency. Regulatory requirements can have positive ex ante effects on incentives, and even if these effects are modeled, the level of liquid assets and capital held by institutions may still be suboptimal from a systemic risk perspective. The paper discusses the LTCM crisis of 1998, where credit interconnections and asset prices contributed to widespread market distress. It also references previous studies on balance sheet interlinkages and systemic risk. The paper highlights that systemic risk in financial networks may be larger than previously thought, especially when market risk is involved. The paper presents a framework for modeling systemic risk, including capital adequacy ratios and equilibrium conditions. It shows that liquidity requirements can mitigate contagion and play a role similar to capital buffers in curtailing systemic failure. The paper also discusses simulations showing how systemic stability is affected by parameters such as capital buffers, liquidity ratios, and interbank linkages. Key findings include that systemic resilience is nonlinearly related to bank interconnections, and that liquidity buffers can be as effective as capital buffers in preventing systemic effects. The paper concludes that prudential regulations, including liquidity and capital requirements, are necessary to ensure financial system stability, as banks do not internalize the externalities of network membership.This paper examines liquidity risk in a system of interconnected financial institutions under regulatory solvency constraints and mark-to-market accounting. When market demand for illiquid assets is not perfectly elastic, sales by distressed institutions can depress asset prices, leading to further sales and price declines. Contagious failures can result from small shocks, and the paper investigates the theoretical basis for these failures through simulations. Liquidity requirements can be as effective as capital requirements in preventing contagious failures. The paper constructs a model with two channels of contagion: direct balance sheet interlinkages and contagion via asset price changes. Changes in asset prices can interact with solvency requirements or internal risk controls to generate amplified endogenous responses. An initial shock that reduces a firm's balance sheet value can lead to asset disposals, which may further depress prices and trigger more sales. This process can amplify the initial shock, leading to systemic risk. The paper argues that asset price contagion alone does not justify opposing prudential regulations or transparency. Regulatory requirements can have positive ex ante effects on incentives, and even if these effects are modeled, the level of liquid assets and capital held by institutions may still be suboptimal from a systemic risk perspective. The paper discusses the LTCM crisis of 1998, where credit interconnections and asset prices contributed to widespread market distress. It also references previous studies on balance sheet interlinkages and systemic risk. The paper highlights that systemic risk in financial networks may be larger than previously thought, especially when market risk is involved. The paper presents a framework for modeling systemic risk, including capital adequacy ratios and equilibrium conditions. It shows that liquidity requirements can mitigate contagion and play a role similar to capital buffers in curtailing systemic failure. The paper also discusses simulations showing how systemic stability is affected by parameters such as capital buffers, liquidity ratios, and interbank linkages. Key findings include that systemic resilience is nonlinearly related to bank interconnections, and that liquidity buffers can be as effective as capital buffers in preventing systemic effects. The paper concludes that prudential regulations, including liquidity and capital requirements, are necessary to ensure financial system stability, as banks do not internalize the externalities of network membership.