Bank Funding Safer Since Crisis

How banks fund themselves is changing for the better, challenges remain

New regulatory reforms will affect how banks fund themselves

Reforms may increase bank funding costs, not as much as markets fear

In new research that is part of the Global Financial Stability Report, the IMF explores how global regulatory reforms will affect how banks fund themselves. The report finds that, under current conditions, the reforms will likely result in small, not drastic increases in the cost most banks incur to fund themselves.

The financial crisis showed that some types of bank funding are dangerous: short-term wholesale funding was a major culprit. When bank’s health started to look dicey, wholesale suppliers of funding decided to pull their money out of banks when their liabilities came due instead of rolling them over. It is now clearer that customer deposits (to provide a stable source of funds) and equity capital (to take losses when they occur) are necessary elements of more stable funding structures.

The crisis also made clear that taxpayers do not want their taxes used to pay for rescues of troubled banks if at all possible. So governments have been keen to revamp their practices for restructuring banks in trouble, especially those perceived as too-important-to-fail. The idea is to give bank supervisors the ability to get bank bondholders to foot some of the bill in case they need to restructure a bank, which is commonly known as a bail in.

”To accomplish this laudable goal, there should be more unsecured debt available to be ‘bailed-in’ before a government is to step into the void—that is, after shareholders lose their potential returns, some debt holders should also bear the burden of a bank’s difficulties—after all they did not purchase “risk free” debt,” said Laura Kodres, chief of the global stability analysis division in the IMF’s Monetary and Capital Markets Department that produced the report.

The IMF report said that policymakers should pay close attention to how these and other reforms interact to affect how banks fund themselves.

For instance, raising bank equity capital and building up liquidity buffers are good, and implementing over-the-counter derivatives reforms is also critical. But policymakers should allow for phase-in periods while monitoring funding conditions.

Tensions arising from reforms

Current reform efforts are designed to improve financial stability, but the IMF’s analysis reveals potential tensions among...