Funding Liquidity Risk Research Articles

The determinants of funding liquidity risk in decentralized lending

The determinants of funding liquidity risk in decentralized lending

A Hierarchical-Dealer-Centric Model of FX Swap Valuation

This paper constructs a model of foreign exchange (FX) swap valuation based on dealers’ behavior and the hierarchy of the global dollar funding system. International investors use these currency derivatives to synthetically fill their US-dollar funding gaps. In this model, three attributes of market structure drive the valuation of FX swaps: market-making costs (measured by dealers’ bid-ask spreads), dollar funding liquidity risk (measured by CIP deviation and market imperfections), and FX swap market liquidity (measured by dealer competition). The goal is to understand how market design influences the cost of US dollar funding and its spillover effects. FX dealers are vital institutions in this ecosystem, as their balance sheets connect national monetary systems to the global dollar funding markets. For currencies with low FX turnover, central banks act as market makers, while private banks serve as dealers for currencies with the highest FX turnover. Studying the “dollar funding gap” through the lens of FX swap dealers is a crucial aspect often overlooked in international finance scholarship.

Foreign bank branch participation and U.S. syndicated loan contract design

I examine whether and how foreign bank branch participation in U.S. loan syndicates influences loan contract design. I predict that foreign bank branches’ dollar funding liquidity risk and information frictions increase renegotiation costs and affect loan contract design. I find that loan contracts with greater foreign bank branch participation include fewer flexibility-reducing covenants, such as capital expenditure and balance sheet covenants, that restrict borrowers from making positive net present value investments. I document similar results using matched sample and plausibly exogenous variation in foreign bank branch participation. Additionally, loan contracts with greater foreign bank branch participation are more likely to feature split control rights, which give banks in revolving lines of credit the exclusive right to renegotiate. In contrast, foreign bank branches are more likely to be included in covenant-lite term loans. Overall, I show that foreign bank branch participation affects U.S. syndicated loan contract design through renegotiation costs.

Funding liquidity risk and the volatility of U.S. municipal green bonds during the COVID-19 pandemic

This study adopts the funding liquidity–market liquidity model developed by Brunnermeier and Pedersen (2009) to investigate the relationship between funding liquidity risk and the volatility of U.S. municipal green bonds during the COVID-19 crisis, while also accounting for other potential risk factors. We observe that during high levels of municipal green bond volatility, the effect of funding liquidity risk on volatility is more pronounced than during periods of low municipal green bond volatility. Moreover, the response of municipal green bond volatility to a shock in the funding liquidity risk is stronger compared to a shock in other risk factors.

Funding liquidity risk: does banking market structure matter?

PurposeThe paper empirically investigates the link between banking market structure and funding liquidity risk.Design/methodology/approachWith a panel of Vietnamese commercial banks from 2007 to 2021, the system generalized method of moments (GMM) estimator is applied as the primary regression method, while the random-effect model and the corrected least square dummy variable (LSDVC) technique are also considered in robustness checks.FindingsCompetition may increase banks' funding liquidity risk. This finding holds for competition measures derived from the Boone index and concentration ratios but not in the case of the Lerner index as a proxy for market power. Further results indicate that the funding liquidity risk of banks that are larger and have better performance (less credit risk and higher return) tends to be less affected by competition. Besides, the overall impact of bank competition on funding liquidity risk is amplified by the financial crisis and the COVID-19 pandemic.Originality/valueThe study extends the empirical literature by exploring the relationship between bank competition and funding liquidity risk. Additionally, the paper also studies how the impact of bank competition on funding liquidity risk depends on the characteristics of the banking sector and the macroeconomic conditions of the economy, including the moderating effect of the COVID-19 pandemic.

Impact of uncertainty and other factors on bank liquidity risk in Vietnam

This paper examines the impact of uncertainty on bank funding liquidity risk (FLR). Based on 31 Vietnamese commercial banks from 2007 to 2019 through two step SGMM estimator and the least squares dummy variable corrected (LSDVC) technique, the study shows evidence that micro uncertainty in the banking sector which is captured by the cross-sectional dispersion of shocks to assets (UncAsset), short-term funding (UncFund) and bank profitability (UncProfit) leads to higher funding liquidity risk, as proxied by lower deposit ratios. Additional analyses reveal that this nexus widely depends on bank heteroge- neity. More precisely, various bank-specific levels that improve banks’ financial strength (i.e., an increase in bank return, loan quality, capitalization, liquid assets, and bank size) tend to mitigate the adverse impact of uncertainty on bank funding liquidity risk. In addition, macro variables are included in the model such as the refinancing rate of the State Bank of Vietnam. Economic cycles reflecting annual GDP changes also contribute to clarify the impact of banking uncertainty on funding liquidity risk. Finally, the study's findings not only demonstrate the robustness for different regression, but also remain unchanged when different bank-level variables are combined used to assess the impact of uncertainty on funding liquidity risk.

Small Banks Really are Different: Unexpected Deposit Flows, Loan Production, and Off-Balance-Sheet Funding Liquidity Risk

Small Banks Really are Different: Unexpected Deposit Flows, Loan Production, and Off-Balance-Sheet Funding Liquidity Risk

Exploring the nexus among the Macroprudential Policies, Funding Liquidity Risk and bank risk of Commercial Banks in Leading South East Asian Economies

The present study explains the behavior of liquidity management, and the macro prudential Policies index and their impact on commercial banks’ risk, particularly on the selected conventional banks in ASEAN countries. The MPP are relatively new in the operations of commercial banks. Hence, more information is needed to understand their impacts on commercial banks’ performance, particularly in the selected conventional banks in ASEAN countries. The major issues in the banking sector of ASEAN countries are asset quality, liquidity risk, and the increasing regulatory pressure from the macro prudential perspectives. Moreover, the study takes a recently developed macro prudential index and its sub-indexes to assess the impact of these on the bank’s risk. Therefore, regulators will be able to utilize this study to enhance the quality of bank assets and choose the most lucrative portfolio. It is vital to highlight that the sample consists mostly of ASEAN-typical institutions. This research will shed light on the general and particular effects of this financing liquidity and MPP index on the BR of ASEAN banks. The dynamic panel is recommended over the static with the assumption that the MPP is likely to change slowly with respect to the change in the whole banking sector that’s why the lag length can help in determining the behavior of whole banking system. Our findings are in line with the new Basel III requirements that necessitate banks to utilize long-term funding sources to equal their fund utilization and to capture further capital in the future considering that these steps can help curtail the risk-taking of banks. Our findings present valuable implications for both market participants and policymakers. By understanding the consequences of the banks’ decision to fund LR and their risk-taking behavior, regulators may find ways to enhance banking regulatory frameworks in order to better control the behaviour of bank managers and to improve financial resilience.
 

The dark side of liquidity regulation: Bank opacity and funding liquidity risk

We evaluate how the liquidity coverage rule affects US banks’ opacity and funding liquidity risk. Banks subject to the rule become significantly more opaque and funding liquidity risk increases by $245 million per quarter. Higher funding liquidity risk is more pronounced among banks that are subject to the rule’s more stringent liquidity buffers, and systemically riskier banks. Rising opacity reflects an increase in banks’ holdings of complex assets whose value is difficult to communicate to investors. The evidence highlights the unintended consequences of liquidity regulation and is consistent with theoretical models’ predictions of a trade-off between liquidity buffers and bank opacity that exacerbates funding liquidity risk.

Does betting against beta strategy work in major Asian Markets?

This study examines the betting against beta (BAB) anomaly and its drivers for five major Asian markets, using data from January 1999 to January 2020. We find positive raw returns-based BAB premiums for India, China, and South Korea, while they are negative in Japan and Indonesia. Cross-sectional differences in BAB premiums seem to be positively associated with the level of information uncertainty and financial market development. Decomposition of the BAB phenomenon shows that BAB premiums are driven by betting against correlation (BAC) premiums in India while betting against volatility (BAV) premiums drive it in China and S.Korea. Funding liquidity risk and margin constraints drive positive BAC in India and Indonesia. Positive BAV in China is driven by MAX (lottery behavior), while idiosyncratic volatility (IVOL) and MAX together drive them in S.Korea. Negative BAB in Japan and Indonesia is mainly due to negative BAV premiums caused by MAX in Japan and both IVOL and MAX in Indonesia. CAPM-based risk-adjusted BAB premiums are not significant for S.Korea, Japan, and Indonesia, while in India and China, they are significant but get explained by the profitability factor. We conclude that the BAB strategy is not universally applicable, and its drivers vary across sample markets.

Fractal characteristics analysis and fluctuation trend prediction of commercial bank funding liquidity

ABSTRACT Funding liquidity has been considered as the lifeline of commercial banks. If there are abnormal fluctuations in funding liquidity, it may lead to bank runs, which may bring about the destruction of commercial banks and even spread to cause a financial crisis. Therefore, exploring the fluctuation characteristics and trend prediction of commercial bank funding liquidity has traditionally attracted much attention. Based on this, this paper analyzes the fluctuation characteristics of commercial bank funding liquidity by Multi-Fractal Detrended Fluctuation Analysis (MF-DFA), and innovatively uses the Moving Trend Entropy Dimension (MTED) for commercial bank funding liquidity fluctuation trend prediction. The results of the study show that the commercial bank funding liquidity is multifractal, so it has predictability; MTED can not only accurately predict the fluctuation trend of commercial bank funding liquidity, but also has robustness. Through effective monitoring of funding liquidity, commercial banks can develop their funding liquidity risk management programs and improve the effectiveness of their own funding liquidity risk control. At the same time, regulators can also achieve the goal of preventing and resolving funding liquidity risks as well as maintaining financial stability.

Interbank liquidity risk transmission to large emerging markets in crisis periods

In this paper, we conduct two investigations regarding funding liquidity risk in large emerging economies: Brazil, Russia, India, China, and South Africa — BRICS. In the first, we track the relevance of monetary policy decisions originating in developed economies for interbank funding liquidity risk in BRICS economies during crisis periods by applying a time-varying parameter model in a Bayesian framework. The results indicate weak associations between interbank credit market and US monetary policy and market conditions. In contrast, the Federal Reserve's National Financial Conditions Index (NFCI) — a representative of the health of both real and financial sectors in the US — matters more. The temporal patterns of the results imply that key central banking decisions precede or coincide with low degrees of associations. In the second, we examine whether interbank credit crunch exerts an influence on market liquidity risk in BRICS economies using a Granger causality approach. The results reveal that interbank credit crunch depresses market liquidity in the corresponding domestic market and that the state of fear and credit market conditions in the US exert some influence in this regard. Overall, our findings hint at judicious market intervention and liquidity management by BRICS central banks.

Funding liquidity risk and asset risk of Indonesian Islamic rural banks

Funding liquidity risk and asset risk of Indonesian Islamic rural banks

Hungarian forint FX swap spreads during and beyond crisis times

Incentivised by a wide range of research discussing mispricing in USD related swap markets, the paper aims at discovering the factors contributing to the deviation of the 3-month FX swap points in the EURHUF and USDHUF market from their CIP based values primarily between the period January 2008 and December 2018 and with an extension to the end of 2021 using daily and monthly Bloomberg quotes. The period examined can be divided into three plus one subperiods as concerns FX swap spreads, largely determined by the effects of the global financial crisis and the volume of FX loans. Apart from the most important classes of variables explaining FX swap spreads, counterparty, funding and market liquidity risk indicators, the literature identifies, policy variables were also involved in the analysis. During and in the aftermath of the 2008 global financial crisis, the MNB applied various kinds of FX swap tenders to ease FX liquidity tensions in the Hungarian interbank market, and continued providing such operations even after the conversion of household FX loans to domestic currency. The results of VARX estimations suggest that indicators of market and liquidity tension, counterparty risk mostly positively contributed to the widening of FX swap spreads, in addition, policy intervention had a spread dampening impact throughout most of the period. The paper confirms that central bank FX swap market participation can mitigate mispricing especially in turbulent times.

Interbank market and funding liquidity risk in a stock‐flow consistent model

AbstractThe present stock‐flow consistent model aims at capturing the second causal link of endogenous monetary theory, from deposits to reserves, by including intrasectoral flows within the banking sector anddebt maturity structuredecisions. For this purpose, banks can choose the demanded duration of interbank loans, either overnight or term, according to a measure for maturity mismatch which captures funding liquidity risk. The simulations show that: (i) a well‐functioning term interbank market is needed when banks face exogenous shocks; and (ii) banks’ funding structure may act as an endogenous source of credit market pressures.

Uncertainty and bank funding liquidity risk in Vietnam

This paper examines the impact of uncertainty on bank funding liquidity risk. Based on a sample of Vietnamese commercial banks from 2007 to 2019, we show evidence that micro uncertainty in the banking sector leads to higher funding liquidity risk, as proxied by lower deposit ratios. Additional analyses reveal that this nexus widely depends on bank heterogeneity. More precisely, various bank-specific forces that improve banks? financial strength (i.e., an increase in bank return, loan quality, capitalization, liquid assets, and bank size) tend to mitigate the adverse impact of uncertainty on bank funding liquidity risk. Our findings are robust to changes in multiple combinations of regressors, different key bank-level variables to calculate the dispersion of shocks as banking uncertainty measures, and alternative econometric approaches.

A funding liquidity risk channel for monetary policy transmission

A funding liquidity risk channel for monetary policy transmission

FX Swap Valuation As a Cost of Filling Dollar Funding Gap: A Hierarchical and Dealer-Centric Perspective

This paper constructs a model of the FX swap valuation, the cost of synthetic dollar borrowing, based on the dealers’ behavior and the hierarchy of international finance. In this model, three fundamentals- market-making costs (measured by dealers’ bid-ask spreads), dollar funding liquidity risk (measured by CIP deviation), and the FX swap market liquidity (measured by the dealers’ competition)- derive the valuation of FX swap. The goal is to understand the financial instability spillovers between FX swaps and offshore US-Dollar funding markets through the “dealers” channel. FX dealers are vital institutions that connect different national monetary jurisdictions in the international monetary system. For currencies where FX turnover is low, market makers are central banks. On the other hand, those dealers are primarily private banks for currencies with the highest FX turnover, such as the US dollar. Nevertheless, studying the “dollar funding gap” through the lens of FX swap dealers is a feature that often gets overlooked in International Political Economy scholarship.

Dynamics of Funding Liquidity and Risk-Taking: Evidence from Commercial Banks

The purpose of this study is to investigate the impact of funding liquidity risk on the banks’ risk-taking behavior. To test the hypotheses, we apply the two-step system GMM technique on US commercial banks data from 2002 to 2018. We find that funding liquidity increases the banks’ risk-taking of US commercial banks. Furthermore, banks with higher deposits are less likely to face a funding shortage, and bank managers’ aggressive risk-taking activity is less likely to be monitored. Our findings infer that increases in bank funding liquidity increase both risk-weighted assets and liquidity creation, and deposit insurance creates a moral risk issue for banks taking excessive risks in response to deposit rises. The relationship between funding liquidity and the banks’ risk-taking varies with their capitalization and market conditions; the impact of funding liquidity on risk-taking is pronounced for well-capitalized banks and the Global Financial Crisis 2007. Our tests are robust for the usage of alternate proxy of funding liquidity and by controlling economic conditions. The findings of this study have implications for regulators to develop guidelines for the level of liquidity and risk-taking of commercial banks.

Cross-trading and liquidity management: Evidence from municipal bond funds

The high flow-performance sensitivity of open-end municipal bond funds motivates fund managers to actively manage funding liquidity risk and reduce the costs of flow-driven transactions. We show that fund families use closed-end funds to provide liquidity to distressed open-end funds by coordinating cross-trading through the internal markets. Larger national funds, funds with lower cash holdings, and fund families with more flexible agency cross-trading policies engage more in liquidity-driven cross-trading. Such cross-trading improves the performance of open-end funds receiving the liquidity provision. Consistent with cross-fund subsidization and family-value maximization, fund families tend to engage low-value closed-end funds in cross-trading for liquidity management.