1 / 15

The Risks of Bank Wholesale Funding

The Risks of Bank Wholesale Funding. Rocco Huang Philadelphia Fed Lev Ratnovski Bank of England. FDIC/Cleveland Fed Conference, April 17, 2008. Asset. Liability. Bank Funding. capital. Deposit. Retail deposits Passive, insured Limited Supply Funded only by deposits?

infinity
Télécharger la présentation

The Risks of Bank Wholesale Funding

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The Risks of Bank Wholesale Funding Rocco HuangPhiladelphia Fed Lev RatnovskiBank of England FDIC/Cleveland Fed Conference, April 17, 2008

  2. Asset Liability Bank Funding capital Deposit • Retail deposits • Passive, insured • Limited Supply • Funded only by deposits? • Excess capital / Unused investment opportunities • Short-term wholesale funds • Need to be rolled over in the short-term; effectively more senior • Source: other financial institutions, non-financial corporations, state and local authorities, foreign entities, etc • Instruments: Fed Funds, Repo’s, Large Certificate of Deposits, Commercial Papers, etc. Wholesale

  3. Asset Liability Short-Term Wholesale Funds capital Deposit • Bright side • Fully exploit investment opportunities • Market discipline (Calomiris, 1999) • Reduced liquidity risks (Goodfriend & King, 1998) • Dark side • Aggressive lending + compromised credit quality • Limited market discipline • Sudden stops + inefficient liquidations • How to reconcile? • When is wholesale funding beneficial? • Can banks opportunistically choose risky wholesale funds? Wholesale

  4. Wholesale funds in the past bank failures • What did short-term wholesale funds learn? • Run! • And you (almost always) get your money back in whole and when you want them • Example 1: Continental Illinois Bank • Noticing its energy sector exposure, wholesale depositors kept withdrawing • The Fed kept lending • Wholesale depositors who withdrew escaped unscathed • So they kept running (why not?) • Retail depositors held the bag

  5. Wholesale funds in the past bank failures • Example 2: Northern Rock • Frightened by U.S. crisis, short-term wholesale funds stopped rolling over financing • After sustaining it for a while, NR finally asked for emergency funding from BoE • …which allowed further exit by wholesale funds • THEN retail deposit run finally started • Short-term wholesale investors didn’t lose a cent • They ran faster than ordinary folks! • Message for wholesale funds • Sometimes they wrongfully liquidate the good guys (Northern Rock), but sometimes they hit the bad guys (Continental) • In any case, it was historically costless to run on a bank with insured depositors!!!

  6. How did short-term wholesale funds escape unscathed? • First-come-first-served gives short-term funds effective seniority • until the bank is taken over by the court / government / FDIC / FHLB • Central bank (and FHLB) by providing liquidity to a failing bank also helps finance their exit • and can potentially increase the FDIC loss • Retail depositors and taxpayers hold the bag • Wholesale funds run based on a noisy signal • Why not?

  7. When is wholesale funding a good thing? • Good when they invest in information • Bad when uninformed • Why do they remain uninformed sometimes? • Monitoring costs not fully compensated when passive depositors freeride • Free, noisy signal reduces incentive for monitoring • Effective seniority allows them to shift the burden of liquidation to passive depositors • Making it more attractive to liquidate based on a noisy, negative signal.

  8. The Model Setup • A bank with a long-term investment project • Date 0: Attract funding, and invest • Date 2: Return (per unit of investment) “Good”: X>>1 w.p. P “Bad”: L<1 w.p. (1-p) • Date 1: L<1 (in liquidation) • Wholesale depositors can • incur a cost and get a precise signal on project quality • Screen out bad banks • or rely on a noisy signal that is precise enough (threshold is endogenous) • Example of signals: • market-wide or sector-wide news; e.g. house price seems to contain a lot of information on banks holding a lot of mortgage-backed securities • Energy price on Penn Central, Continental, etc

  9. Bank Depositors only Attractwholesale funds Date 0 Providers of wholesale funds Screen, lend to good banks only Do not screen, lend to all banks Date 1 Upon a noisy negative signal, stay Upon a negative signal, liquidate

  10. What are they thinking? • Wholesale funds: • Get Informed? Depositors free-ride the benefits • Remain Uninformed? Costs of liquidation burdened by the depositors • Incentives distorted by: • Effective seniority over passive depositors • Availability of a free, noisy signal • Banks: • Deposits only? excess capital • Attract wholesale? Can have higher liquidity risk • Incentives distorted by limited liability • Society: • Lending to “bad” projects never optimal [market discipline] • Early liquidation never optimal[liquidity risk]

  11. DSW*** D*** 0 D* D** 1 D Uninformed,but stay upon a negative signal Uninformed,and liquidate upon a negative signal Wholesale financiers Informed Bank Doesnotuse Uses wholesale funds The bank uses wholesale funds, although it is not socially optimal Results from the model

  12. Distorted incentives • Wholesale financiers • Low incentives to screen = Insufficient market disciplineDo not internalize benefits for depositors • High incentives to liquidate = Liquidity risk Withdraw before the depositors, enjoying effective seniority, and thus larger share of a smaller pie • Banks • Over-reliance on risky wholesale fundsLimited Liability; Do not internalize risks of depositors

  13. Is wholesale funding bad? • Less risky if: • Predominantly wholesale • Wholesale not necessarily a problem per se • They seem to be more “reasonable” in financial institutions without much retail deposits • They sat down and bailed LTCM out • They maintained credit lines to Countrywide • Exception: Bear Stearns – people just hated BS for its LTCM role? ? • Predominantly deposits • But: no monitoring; and excess capital • More risky if: • Combination of deposits and wholesale • Use of wholesale funds in depository banks • Insufficient market discipline • Heightened liquidity risks

  14. Model v.2.0. • New model • Endogenous (optimal) arrangement of seniority [0,1] • Endogenous choice of monitoring intensity [0,1] • Optimal seniority arrangement: • Unlike in Calomiris and Kahn (1991), seniority is not always good • Wholesale funds should be made more junior if: • Share of passive retail depositors is higher • The precision of the noisy signal is higher • e.g. For banks holding mainly mortgage-backed securities vs. loans • Liquidation cost is smaller • Inverse U-shaped relationship between monitoring and seniority • Monitoring efforts maximized in the middle • Lower seniority -> incentives not aligned • Higher seniority -> liquidate too often

  15. Thank you!!

More Related