The Dark Side of Bank Wholesale Funding

R. Huang, L. Ratnovksi

Research output: Working paperDiscussion paperOther research output

Abstract

Commercial banks increasingly use short-term wholesale funds to supplement traditional retail deposits. Existing literature mainly points to the "bright side" of wholesale funding: sophisticated financiers can monitor banks, disciplining bad ones but refinancing solvent ones. This paper models a "dark side" of wholesale funding. In an environment with a costless but imperfect signal on bank project quality (e.g., credit ratings, performance of peers), short-term wholesale financiers have lower incentives to conduct costly information acquisition, and instead may withdraw based on negative but noisy public signals, triggering inefficient liquidations. We show that the "dark side" of wholesale funding dominates the "bright side" when bank assets are more arm's length and tradable (leading to more relevant public signals and lower liquidation costs): precisely the attributes of a banking sector with securitizations and risk transfers. The results shed light on the recent financial turmoil, explaining why some wholesale financiers did not provide market discipline ex-ante and exacerbated liquidity risks ex-post.
Original languageEnglish
Place of PublicationTilburg
PublisherFinance
Number of pages51
Volume2009-18 S
Publication statusPublished - 2009

Publication series

NameEBC Discussion Paper
Volume2009-18 S

Fingerprint

Funding
Retail
Market discipline
Credit rating
Liquidity risk
Costly information
Deposits
Liquidation
Information acquisition
Peers
Assets
Incentives
Commercial banks
Liquidation costs
Securitization
Risk transfer
Refinancing
Banking sector

Keywords

  • Banks
  • Crises
  • Funding
  • Deposits
  • Bank Runs
  • Monitoring
  • Market Discipline

Cite this

Huang, R., & Ratnovksi, L. (2009). The Dark Side of Bank Wholesale Funding. (EBC Discussion Paper; Vol. 2009-18 S). Tilburg: Finance.
Huang, R. ; Ratnovksi, L. / The Dark Side of Bank Wholesale Funding. Tilburg : Finance, 2009. (EBC Discussion Paper).
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Huang, R & Ratnovksi, L 2009 'The Dark Side of Bank Wholesale Funding' EBC Discussion Paper, vol. 2009-18 S, Finance, Tilburg.

The Dark Side of Bank Wholesale Funding. / Huang, R.; Ratnovksi, L.

Tilburg : Finance, 2009. (EBC Discussion Paper; Vol. 2009-18 S).

Research output: Working paperDiscussion paperOther research output

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AU - Ratnovksi, L.

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AB - Commercial banks increasingly use short-term wholesale funds to supplement traditional retail deposits. Existing literature mainly points to the "bright side" of wholesale funding: sophisticated financiers can monitor banks, disciplining bad ones but refinancing solvent ones. This paper models a "dark side" of wholesale funding. In an environment with a costless but imperfect signal on bank project quality (e.g., credit ratings, performance of peers), short-term wholesale financiers have lower incentives to conduct costly information acquisition, and instead may withdraw based on negative but noisy public signals, triggering inefficient liquidations. We show that the "dark side" of wholesale funding dominates the "bright side" when bank assets are more arm's length and tradable (leading to more relevant public signals and lower liquidation costs): precisely the attributes of a banking sector with securitizations and risk transfers. The results shed light on the recent financial turmoil, explaining why some wholesale financiers did not provide market discipline ex-ante and exacerbated liquidity risks ex-post.

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KW - Bank Runs

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Huang R, Ratnovksi L. The Dark Side of Bank Wholesale Funding. Tilburg: Finance. 2009. (EBC Discussion Paper).