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This paper investigates the determinants of bank funding costs for a sample of internationally active banks from 2001–12. We find that changes in banks’ unsecured funding costs are associated with bank-specific characteristics such as an institution’s credit worthiness and the return on its market value, and importantly, on the level and quality of capital. Similarly, market factors such as the level of investor risk appetite, as well as shocks to financial markets—notably the US subprime crisis and the Euro Area sovereign debt crisis—have also been key drivers of the sharp rise in bank funding costs. We also find evidence that large systemically important institutions have enjoyed a funding advantage, and that this advantage has risen since the onset of the two crises. With the exception of Euro Area periphery banks, by end-2012 the rise in funding costs had generally been reversed for most major banks as a result of improvments in bank asset quality as well as steps taken to increase resilience, notably higher capitalization. Our results suggest increased capital buffers may potentially support bank lending to the real economy by reducing bank funding costs.
This paper presents new evidence on the empirical relationship between bank solvency and funding costs. Building on a newly constructed dataset drawing on supervisory data for 54 large banks from six advanced countries over 2004–2013, we use a simultaneous equation approach to estimate the contemporaneous interaction between solvency and liquidity. Our results show that liquidity and solvency interactions can be more material than suggested by the existing empirical literature. A 100 bps increase in regulatory capital ratios is associated with a decrease of bank funding costs of about 105 bps. A 100 bps increase in funding costs reduces regulatory capital buffers by 32 bps. We also find evidence of non-linear effects between solvency and funding costs. Understanding the impact of solvency on funding costs is particularly relevant for stress testing. Our analysis suggests that neglecting the dynamic features of the solvency-liquidity nexus in the 2014 EU-wide stress test could have led to a significant underestimation of the impact of stress on bank capital ratios.
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.
The crisis in Europe has underscored the vulnerability of European bank funding models compared to international peers. This paper studies the drivers behind this fragility and examines the future of bank funding, primarily wholesale, in Europe. We argue that cyclical and structural factors have altered the structure, cost, and composition of funding for European banks. The paper discusses the consequences of shifting funding patterns and investor preferences and presents possible policy options and bank actions to enhance European bank funding models’ robustness.
Leading up to the global financial crisis, US dollar activity by global banks headquartered outside the United States played a crucial role in transmitting shocks originating in funding markets. Although post-crisis regulation has improved banking systems’ resilience, US dollar funding remains a global vulnerability, as evidenced by strains that reemerged in March 2020 in the midst of the COVID-19 crisis. We show that shocks to US dollar funding costs lead to financial stress in the home economies of these global non-US banks, and to spillovers to borrowers, especially emerging economies. US dollar funding vulnerability amplifies these negative effects, while some policy-related factors act as mitigators, such as swap line arrangements between central banks and international reserve holdings. Thus, these vulnerabilities should be monitored and, to the extent possible, controlled.
We analyze the long-term funding costs faced by banks from US, UK and euro-area on the international bond market with a focus on the value of implicit and explicit public guarantees. By looking at the risk-premia at issuance on 5,500 bonds, we find that: i) both explicit guarantees as well as sovereign creditworthiness have a substantial effect on the cost of bonds; ii) large institutions enjoy lower issuance costs, most likely due to the too-big-to-fail safety net; iii) since the onset of the global financial crisis, systemic banks (the so called G-SIFIs) underwent an enhanced market discipline paying an additional premium on new bond issuances. In particular, we show that non AAA-rated governments add a burden to the cost of debt issuance by the domestic banking system. This implicit negative support intensified in the most acute phase of the euro-area sovereign debt crisis: we estimate that the absence of the backing of an AAA-rated government amounted, ceteris paribus, to an average increase of 150bp in the cost paid by banks when issuing unsecured bonds in 2011. However, once we restrict the sample to banks for which CDS spreads are priced in the market - usually larger institutions which are more involved in the issuance activity - we find that the bond premium reflects more closely the characteristics of each institution (soundness and creditworthiness), with the role of government somewhat reduced. By distinguishing between banks' absolute size and systemic relevance, we find that financial investors were able to disentangle the two issues. Or results suggest that the larger the magnitude of the balance sheet the lower the premium paid at launch on bonds, which in turn suggests that the safety net benefits granted to too-big-to-fail institutions encompass also lower funding costs on the primary bond market. At the same time, we find that there are matters of concern regarding the systemic relevance of financial institutions: their involvement in complex derivative trades and their business model have made them less transparent and less easy to price. In this respect we find evidence of enhanced market discipline: since the onset of the global financial crisis systemically important banks - which before the crisis were enjoying a reduction in the spread - paid, ceteris paribus, a larger premium of around 50 basis points on their bond issuance.
The appropriate level of bank capital and, more generally, a bank’s capacity to absorb losses, has been at the core of the post-crisis policy debate. This paper contributes to the debate by focusing on how much capital would have been needed to avoid imposing losses on bank creditors or resorting to public recapitalizations of banks in past banking crises. The paper also looks at the welfare costs of tighter capital regulation by reviewing the evidence on its potential impact on bank credit and lending rates. Its findings broadly support the range of loss absorbency suggested by the Financial Stability Board (FSB) and the Basel Committee for systemically important banks.
Volatility in Italian sovereign spreads has increased since mid-2011. This paper finds that news on the euro area debt crisis and country specific events were important drivers of sovereign spreads. Movements in sovereign spreads affect CDS spreads and bond yields of Italian banks, and are transmitted rapidly to firm lending rates. Banks with lower capital ratios and higher nonperforming loans were found to be more sensitive to swings in sovereign spreads. Credit supply constraints due to bank funding shortages from the sovereign debt crisis were a major factor behind the lending slowdown in late 2011, while in 2012 weak demand appears to have been driving changes in credit more than supply.
Following a scarcity of dollar funding available internationally to banks and financial institutions, in Dec. 2007 the Federal Reserve began to establish or expand Temporary Reciprocal Currency Arrangements with 14 foreign central banks. These central banks had the capacity to use these swap facilities to provide dollar liquidity to institutions in their jurisdictions. This paper presents the developments in the dollar swap facilities through the end of 2009. The facilities were a response to dollar funding shortages outside the U.S. during a period of market dysfunction. The dollar swap lines among central banks were effective at reducing the dollar funding pressures abroad and stresses in money markets. Charts and tables.