Wholesale funding is the money a bank raises from professional sources, such as other banks, money market funds, large companies, pension funds, insurers and bond investors, as opposed to deposits collected from households and small businesses. It includes short-term borrowing in the money markets and long-term debt issued in the capital markets. Non-bank lenders, which cannot take deposits, rely on it entirely.
Banks use wholesale funding to finance lending that exceeds their deposit base, to manage day-to-day liquidity, to borrow in foreign currencies and to meet regulatory requirements for loss-absorbing debt. It can be raised quickly and in large amounts, but its providers are well informed and sensitive to risk, and they can withdraw far faster than ordinary savers. How much a bank depends on it, and at what maturities, is therefore a central question in liquidity risk management and in supervisors' assessment of a bank's funding model.
Main sources
- Unsecured interbank borrowing. Loans and deposits between banks, from overnight to about a year, priced by reference to the interbank rate or its successors.
- Large deposits. A wholesale deposit placed by a corporation, fund or public body, often well above deposit insurance limits.
- Short-term paper. Commercial paper and certificates of deposit sold mainly to money market funds.
- Repo. Borrowing against securities under a repurchase agreement, the largest secured short-term market.
- Long-term unsecured debt. Senior bonds, subordinated debt and other instruments that count towards capital or resolution requirements.
- Secured term funding. Covered bonds and securitisations backed by mortgages or other loans, and credit lines such as a warehouse facility.
- Central bank funding. Borrowing from the central bank against collateral, in regular operations or in emergencies.
Advantages and risks
Wholesale markets let a bank grow faster than its deposit franchise would allow, match the currency and term of specific assets, and diversify away from a single customer base. In normal conditions short-term wholesale money is also cheap.
The main risk is rollover risk. A bank that funds long-term loans with borrowing that matures in days or weeks must renew that borrowing continually, an extreme form of maturity transformation. If lenders doubt the bank's soundness, or if markets seize up generally, they simply decline to renew, and because they are few and large the effect is immediate. Secured funding is more stable than unsecured, but lenders can raise haircuts or refuse lower-quality collateral, and heavy use of secured funding leaves fewer unencumbered assets for other creditors. The cost of wholesale funding also moves quickly with the bank's credit standing, which squeezes margins when conditions worsen.
Role in the 2007 to 2009 crisis
Reliance on short-term wholesale funding was a common factor in the failures of the 2008 financial crisis. Northern Rock, a British mortgage lender that funded most of its lending through securitisation and wholesale borrowing, could no longer refinance when those markets froze in August 2007 and needed emergency support from the Bank of England, followed by a run by retail depositors. In the United States, investment banks financed large securities holdings in the overnight repo market; Bear Stearns and Lehman Brothers lost that funding within days in 2008. After Lehman's failure a money market fund's losses on its commercial paper triggered withdrawals from similar funds, cutting off dollar funding to banks worldwide. Central banks responded by lending on an unprecedented scale. The episode is sometimes described as a run on wholesale markets, in contrast to a traditional bank run.
Regulation
The liquidity standards of Basel III were designed largely with wholesale funding in mind. The liquidity coverage ratio requires a bank to hold enough high-quality liquid assets to cover net cash outflows over a 30-day stress, and it assumes that unsecured funding from financial institutions runs off completely in that period, while stable retail deposits lose only a small percentage. The net stable funding ratio requires long-term assets to be backed by funding regarded as stable over one year, giving little or no credit to short-term wholesale borrowing. Supervisors also monitor concentration of funding by counterparty, instrument and currency, and require a contingency funding plan setting out how a bank would replace funding that is lost.
Management in practice
A bank's treasury sets targets for the mix and term of funding in its bank funding plan, spreads maturities so that no single period carries too much refinancing, as shown in its maturity profile, and maintains a presence across several markets and investor groups. Analysts follow measures such as the loan-to-deposit ratio and the share of short-term wholesale funding in total liabilities. Since the crisis, large banks have generally lengthened the term of their market borrowing and increased deposits, while a significant share of long-term issuance is now driven by requirements for loss-absorbing capacity and not by the need for liquidity.