This paper explores the impact of liquidity risk in a system of interconnected financial institutions, particularly when these institutions are subject to regulatory solvency constraints and mark their assets to market. The authors investigate how small shocks can lead to contagious failures and quantify these effects through simulations. They find that the combination of mark-to-market accounting and solvency constraints can induce endogenous responses that amplify initial shocks, potentially leading to systemic instability. The paper also highlights that liquidity requirements can be as effective as capital requirements in preventing contagious failures, especially when the demand for illiquid assets is less than perfectly elastic. The authors conclude that prudential regulations, such as liquidity and capital requirements, can have both positive and negative effects on systemic stability, and that liquidity buffers can play a similar role to capital buffers in curbing systemic risk.This paper explores the impact of liquidity risk in a system of interconnected financial institutions, particularly when these institutions are subject to regulatory solvency constraints and mark their assets to market. The authors investigate how small shocks can lead to contagious failures and quantify these effects through simulations. They find that the combination of mark-to-market accounting and solvency constraints can induce endogenous responses that amplify initial shocks, potentially leading to systemic instability. The paper also highlights that liquidity requirements can be as effective as capital requirements in preventing contagious failures, especially when the demand for illiquid assets is less than perfectly elastic. The authors conclude that prudential regulations, such as liquidity and capital requirements, can have both positive and negative effects on systemic stability, and that liquidity buffers can play a similar role to capital buffers in curbing systemic risk.