Short Term Bank Funding

Question 1

Primary source of funding for deposit -taking banks?

Answer 1

For deposit-taking banks, the primary source of funding is their retail deposit customers.

Question 2

What retail deposits are there for deposit-taking banks?

Answer 2

• Two retail deposit accounts: demand deposit and saving account.
• Demand deposit account: a.k.a. checking account allow customers to access the funds in their account immediately to make payment. Therefore, accounts typically pay no interest.
• Saving account has maturity and pays customers interest. But customers miss the convenience to withdraw fund “on demand”.

Question 3

What is short-term wholesale funding?

Answer 3

• Retail deposit funding may not be sufficient to fund banks’ operation business, so second source of funding is short-term wholesale fund.
• Short-term wholesale funding includes funds from central bank, interbank loan, and certificate of deposit (CD).

Question 4

Why do many countries require deposit-taking banks to place a reserve balance with national central banks.

Answer 4

In aggregate, the reserve funs act as liquidity buffer providing comfort to depositors and investors that all banks depositing reserve with the central bank will not have to worry about liquidity shortage, a mechanism known as lender of last resort.

Question 5

What is the central bank fund market?

Answer 5

Central bank fund market allows banks with surplus of funds to loan money to banks lack of funds for maturity up to one year.
These funds known as overnight funds for maturity of one day, or term funds for maturity in the range of 2-day to 1-year.

• The interest rate, known as central bank fund rate, at which central bank funds are borrowed and lent are short-term interest rate, which is determined by the market but also influenced by the central bank’s open market operation.

Question 6

What is the interbank market?

Answer 6

• Interbank market is a market of loans and deposits between banks
• The interest rate is known as interbank offer rate. The maturity ranges from overnight to one year.
• Interbank deposit is unsecured, so banks placing deposits with another bank need to have an interbank line of credit for that institutions.

Question 7

What is a certificate of deposit?

Answer 7

• Certificate of deposit (CD) refers to a specified amount of
funds on deposit for a specified maturity and interest rate.

Question 8

What are negotiable and non-negotiable CDs?

Answer 8

• Negotiable CD holders (money depositor) can sell the CD in an open market.

Question 9

What are Repurchase agreements? (REPO)

Answer 9

Repurchase agreements are an important source of
funding not only for banks but also for other market
participants.

A repurchase agreement, or repo, is the sale of a
security with a simultaneous agreement by the seller
to buy the same security back from the purchaser at
an agreed-on price and future date.

A repurchase agreement can be viewed as a
collateralized loan in which the security sold and
subsequently repurchased represents the collateral
posted.

Question 10

Credit risk of Repos

Answer 10

• Although repo transactions are backed up by collaterals, both parties are subject to credit risk (or default risk).
• The market worries more about risk on the seller side because the collateral could be subject to discount in distressed market conditions, like in 2008
financial crisis

Question 11

What is the repo margin or haircut?

Answer 11

• The difference between the market value of the collateral and the purchase price by the buyer is known as repo margin or haircut.