Wholesale Funding Research Articles

International Banking Conglomerates and the Transmission of Lending Shocks Across Borders

We investigate how solvency and wholesale funding shocks to 84 OECD parent banks affect the lending of 375 foreign subsidiaries. We find that parent solvency shocks are more important than wholesale funding shocks for subsidiary lending. Furthermore, we find that parent undercapitalization does not affect the transmission of shocks, while wholesale shocks transmit to foreign subsidiaries of parents that rely primarily on wholesale funding. We also find that transmission is affected by the strategic role of the subsidiary for the parent and follows a locational, rather than an organizational pecking order. Surprisingly, liquidity regulation exacerbates the transmission of adverse wholesale shocks. We further document that parent banks tend to use their own capital and liquidity buffers first, before transmitting. Finally, we show that solvency shocks have higher impact on large subsidiary banks with low growth opportunities in mature markets.

Asset Encumbrance, Bank Funding and Fragility

We propose a model of asset encumbrance by banks subject to rollover risk and study the consequences for fragility, funding costs, and prudential regulation. A bank’s choice of encumbrance trades off the benefit of expanding profitable investment funded by cheap long-term secured debt against the cost of greater fragility due to unsecured debt runs. We derive several testable implications about privately optimal encumbrance ratios. Deposit insurance or wholesale funding guarantees induce excessive encumbrance and exacerbate fragility. We show how regulations such as explicit limits on encumbrance ratios and revenueneutral Pigouvian taxes can mitigate the risk-shifting incentives of banks. JEL Classification: G01, G21, G28

Rollover Risk, Liquidity and Macroprudential Regulation

I study rollover risk in wholesale funding markets when intermediaries hold liquidityex anteand fire sales may occurex post. Multiple equilibria exist in a global rollover game: intermediate liquidity holdings support equilibria with both positive and zero expected liquidation. A simple uniqueness refinement pins down the private liquidity choice, which balances the forgone expected return on investment with reduced fragility and costly liquidation. Due to fire sales, liquidity holdings are strategic substitutes. Intermediaries free ride on the holdings of other intermediaries, causing excessive liquidation. To internalize the systemic nature of liquidity, a macroprudential authority imposes liquidity buffers.

Wholesale funding and the increase in construction bank-owned real estate in the US financial crisis

ABSTRACTThe housing crisis left some metropolitan areas littered with partially constructed subdivisions and developments. Most of these failed developments were built by small construction firms reliant on small banks for finance. Failed construction projects became bank-owned real estate (REO), prolonging the crisis and contributing to an uneven recovery. But there is little research on the spatial distribution or financial processes driving construction REO. I use a finance-as-spatial fix theorization to describe increasing interrelation between construction lending and global capital markets through wholesale funding, and the subsequent buildup of construction REO. Wholesale funding allows small banks to access money markets. Controlling for economic growth, the home price bubble, and financial institutions, I use a national panel regression to identify key factors associated with high levels of construction REO in urban areas. Consistent with a finance-as-spatial-fix analysis, the strongest determinant of construction REO was the type of capital flows into small banks.

The bank-lending channel empirically revisited

This study examines the role of bank equity and bank lending in the monetary transmission mechanism in Norway from January 1993 to August 2008. We apply linear and nonlinear vector-auto-regressive models (VARs) estimated using aggregate monthly data. The results provide support for a “risk-taking channel” in the form of a recasted bank-lending channel running through market-based wholesale funding, in which the impact of monetary policy depends on banks’ financial strength. When banks are weakly capitalized, results based on a nonlinear VAR show a larger monetary-policy effect on real activity.

Macroprudential policy in a recovering property market: too much too soon?

The aftermath of the 2007/2008 financial crisis has resulted in many central banks and regulatory authorities examining the effectiveness of macroprudential policy in preventing the emergence of future credit bubbles. Specific limits on loan-to-value (LTV) and loan-to-income (LTI) ratios have been introduced in a number of economies as a means of ensuring greater financial stability. The Irish property and credit market were particularly affected in the crisis as the domestic housing market had, since 1995, experienced sustained price and housing supply increases. Much of the activity in the Irish market was fuelled by a credit bubble following the emergence of international wholesale funding post 2003. After a period of pronounced declines, Irish house prices in late 2013 started to increase significantly; in early 2015, in response, the Irish Central Bank imposed new LTV and LTI limits to curb house price inflation. However, the introduction of these measures comes at a time when housing supply and mortgage lending are still at historically low levels. Therefore, in this paper we use a newly developed structural model of the Irish property and credit market to examine the implications of these measures for house prices and key activity variables in the mortgage market.

Banks’ Exposure to Rollover Risk and the Maturity of Corporate Loans*

In this article, we show that when banks increase their use of wholesale funding they shorten the maturity of loans to corporations. This effect appears to be linked to banks’ exposure to rollover risk resulting from their increasing use of short-term uninsured funding. Banks that use more wholesale funding shorten both the maturity of newly issued loans and the maturity of their loan portfolios. These results are not present among banks that rely predominantly on insured deposits. The link between wholesale funding and loan maturity is robust, and holds when we include firm-year fixed effects, suggesting that the decline in loan maturity is bank driven. In line with this premise, we find that the slope of the loan yield curve becomes steeper for banks that use more wholesale funding and that borrowers turn to the bond market to raise funding with longer maturity in response to banks’ loan maturity shortening.

Securities Lending as Wholesale Funding: Evidence from the U.S. Life Insurance Industry

The existing literature implicitly or explicitly assumes that securities lenders primarily respond to demand from borrowers and reinvest their cash collateral through short-term markets. Using a new dataset that matches every U.S. life insurer’s bond portfolio, as well as their lending and reinvestment decisions, to the universe of securities lending transactions, we offer compelling evidence for an alternative strategy, in which securities lending programs are used to finance a portfolio of long-dated assets. We discuss how the liquidity and maturity mismatch associated with using securities lending as a source of wholesale funding could potentially impair the functioning of the securities market.

Are the Funding Strategies and Bank Risk Different in Greenfield and Takeover Banks? Evidence from Foreign Banks in Bulgaria

This paper examines the implications of entry mode and funding strategy for bank risk using data on foreign banks in Bulgaria from April 2004 to March 2014. We find that the two types of foreign entry modes - greenfield and takeover - differ in terms of funding strategy, particularly with regard to reliance on wholesale funding. Taken together with the influence of bank funding structure on risk, this heterogeneity, with respect to funding strategy, leads to different levels of default risk between the two entry modes. This finding suggests that the entry mode has an indirect effect on the increasing vulnerabilities of foreign banks, with the effect occurring through the funding strategy. Moreover, we confirm the existence of a close link between the mode of foreign entry and bank risk, even when controlling for funding strategy. We interpret this as evidence of a direct effect of entry mode on the risk of foreign banks in the host country, independent of funding structure.

Sovereign risk, interbank freezes, and aggregate fluctuations

This paper shows how spillovers from sovereign risk to banks׳ access to wholesale funding establish a bank-sovereign nexus. In a dynamic stochastic general equilibrium set-up, heterogeneous banks give rise to an interbank market where government bonds are used as collateral. Government borrowing under limited commitment is costly ex ante as bank funding conditions tighten when the quality of collateral drops. These spillovers, by impeding interbank intermediation, lower the penalty from defaulting due to an interbank freeze during a recession and propagate aggregate shocks to the macroeconomy. The model is calibrated using Greek data and is capable of reproducing stylized facts from the European sovereign debt crisis. In an application, we show that the ECB׳s non-standard financing operations mitigate the adverse feedback mechanism.

Federal Home Loan Bank Advances and Small Business Lending

Adequate credit availability for small businesses is an important public policy issue because small businesses are essential for employment and economic growth for the economy. The Gramm-Leach-Bliley Act of 1999 includes a provision that could potentially support financial institutions in the provision of credit to small businesses through the use of advances from the Federal Home Loan Bank (FHLB) system that are secured with small business loans. We explore the relation between FHLB advances to financial institutions and the provision of loans to small businesses. We find a positive link between the change in FHLB advances and the change in small business loans and the level of FHLB advances and the level of small business loans. This relation holds for large and small banks and pre- and post-2007 recession. However, we find that the change in the proportion of small business loans to assets is only positively related to the change in the advances to assets ratio prior to the recessionary period. This suggests that banks substitute small business loans for other types of assets during relatively normal economic periods, but FHLB advances are a source of wholesale funds that will be invested in the most attractive financial assets available with no preference for any particular asset during periods of contracting credit.

Lenders on the Storm of Wholesale Funding Shocks: Saved by the Central Bank?

We provide empirical evidence on banks’ responses to shocks in wholesale funding, using data of 181 euro area banks over the period August 2007 to June 2013. Banks’ adjustments of loan volumes and lending rates in response to funding liquidity shocks are analysed in a panel VAR framework. The results show that shocks in the securities and interbank markets have significant effects on loan rates and credit supply, particularly of banks in stressed countries. The results also suggest that central bank liquidity has mitigated this effect most clearly on lending volumes. Lending to non-financial corporations is more sensitive to wholesale funding shocks than lending to households. Moreover, bank characteristics matter for monetary transmission: loan growth of large banks that are typically more dependent on wholesale funding and of banks with large exposure to government bonds shows relatively stronger responses to wholesale funding shocks.

The Effect of Monetary Policy on Bank Wholesale Funding

We study how monetary policy affects the funding composition of the banking sector. When monetary tightening reduces the retail deposit supply due to, for example, a decrease in bank reserves or in money demand, banks try to substitute the deposit outflows with more wholesale funding in order to mitigate the policy impact on their lending. Banks have varying degrees of accessibility to wholesale funding sources because of financial frictions, and those banks that are large or that have a greater reliance on wholesale funding increase their wholesale funding more. As a result, monetary tightening increases both the reliance on and the concentration of wholesale funding within the banking sector, indicating that monetary tightening could increase systemic risk. For identification, we exploit regional age-demographics of bank customer-base as a measure of retail deposit supply elasticity to interest rate changes, and compare the effect on large and small banks within the age-demographic groups. Our findings also suggest that introducing liquidity requirements can bolster monetary policy transmission through the bank lending channel by limiting the funding substitution of large banks.

Countercyclical Foreign Currency Borrowing: Eurozone Firms in 2007-2009

Despite international financial disintegration, we document a dramatic increase in dollar borrowing among leveraged Eurozone corporates during the Great Financial Crisis. Using loan-level data, we trace this increase to the twin crisis in the credit market and in funding markets. The reduction in the supply of credit by Eurozone banks caused riskier borrowers to shift to foreign banks, in particular US banks. The coincident rise in the relative cost of euro wholesale funding and the disruptions in the FX swap market caused a rise in dollar borrowing from US banks, especially for firms in export-oriented sectors. Although global bank lending is often reported to amplify the international credit cycle, we show that foreign banking acted as a shock absorber that weathered the real consequences of the credit crunch in Europe.

Lenders on the Storm of Wholesale Funding Shocks: Saved by the Central Bank?

We provide empirical evidence on banks' responses to shocks in wholesale funding, using data of 181 euro area banks over the period August 2007 to June 2013. Banks' adjustments of loan volumes and lending rates in response to funding liquidity shocks are analysed in a panel VAR framework. The results show that shocks in the securities and interbank markets have significant effects on loan rates and credit supply, particularly of banks in stressed countries. Central bank liquidity has mitigated this effect. Lending to non-financial corporations is more sensitive to wholesale funding shocks than lending to households. Moreover, bank characteristics matter for monetary transmission: loan growth of large banks that are typically more dependent on wholesale funding and of banks with large exposure to government bonds shows relatively stronger responses to wholesale funding shocks.

Wholesale Banking and Bank Runs in Macroeconomic Modeling of Financial Crises

There has been considerable progress in developing macroeconomic models of banking crises. However, most of this literature focuses on the retail sector where banks obtain deposits from households. In fact, the recent financial crisis that triggered the Great Recession featured a disruption of wholesale funding markets, where banks lend to one another. Accordingly, to understand the financial crisis as well as to draw policy implications, it is essential to capture the role of wholesale banking. The objective of this paper is to characterize a model that can be seen as a natural extension of the existing literature, but in which the analysis is focused on wholesale funding markets. The model accounts for both the buildup and collapse of wholesale banking, and also sketches out the transmission of the crises to the real sector. We also draw out the implications of possible instability in the wholesale banking sector for lender-of-last resort policy as well as for macroprudential policy.

Negative Interest Rates: How Big a Challenge for Large Danish and Swedish Banks?

Negative policy interest rates have prevailed for some years in Denmark and are a more recent development in Sweden. Among other potential side effects, negative rates could weaken banks' profitability by reducing net interest income, their main source of earnings. However, an analysis of financial statements at the country rather than the consolidated group level shows that bank margins have been broadly stable. At least to date, lower interest income was offset by reductions in wholesale funding costs and higher fee income. Nonetheless, the impacts on bank health and lending from negative interest rates will need to continue to be monitored closely.

Bank Solvency and Funding Cost

Understanding the interaction between bank solvency and funding cost is a crucial pre-requisite for stress-testing. In this paper we study the sensitivity of bank funding cost to solvency measures while controlling for various other measures of bank fundamentals. The analysis includes two measures of bank funding cost: (a) average funding cost and (b) interbank funding cost as a proxy of wholesale funding cost. The main findings are: (1) Solvency is negatively and significantly related to measures of funding cost, but the effect is small in magnitude. (2) On average, the relationship is stronger for interbank funding cost than for average funding cost. (3) During periods of stress interbank funding cost is more sensitive to solvency than in normal times. Finally, (4) the relationship between funding cost and solvency appears to be non-linear, with higher sensitivity of funding cost at lower levels of solvency.

Negative Interest Rates: How Big a Challenge for Large Danish and Swedish Banks?

Negative policy interest rates have prevailed for some years in Denmark and are a more recent development in Sweden. Among other potential side effects, negative rates could weaken banks’ profitability by reducing net interest income, their main source of earnings. However, an analysis of financial statements at the country rather than the consolidated group level shows that bank margins have been broadly stable. At least to date, lower interest income was offset by reductions in wholesale funding costs and higher fee income. Nonetheless, the impacts on bank health and lending from negative interest rates will need to continue to be monitored closely.

Wholesale Funding Runs

We empirically explore the fragility of wholesale funding of banks, using transaction level data on short-term, unsecured certificates of deposits in the European market. We do not observe any market-wide freeze during the 2008-2014 period. Yet, many banks suddenly experience funding dry-ups. Dry-ups predict, but do not cause, future deterioration of bank performance. Furthermore, in periods of market stress, banks with high future performance tend to increase reliance on wholesale funding. Thus, we fail to find evidence consistent with adverse selection models of funding market freezes. Our results are in line with theories highlighting heterogeneity between informed and uninformed lenders.