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Bank funding had already seen major changes in the years prior to the euro area crisis. During the past few decades, banks loosened the constraints of deposit growth and raised funds from institutional investors in global financial markets. They tapped new sources of funding, such as securitisation. The business model of investment banks relied on wholesale funding from institutional investors, especially at short maturities. Financial globalisation allowed banks to tap institutional investors beyond national borders, which expanded traditional international funding to international interbank markets.
This article investigates how bank funding in the euro area in recent years reflected these market developments. In fact, bank funding can be seen as the area where important issues related to the crisis and financial markets come together. It should be emphasised that this analysis simplifies a very complex reality, with profound differences among different financial institutions and countries.
First, adverse feedback effects between the weaknesses of sovereigns and banks disrupted funding markets severely. During episodes of severe sovereign strains, access to short- and longer-term wholesale funding markets became problematic even for euro area banks with the highest credit ratings, forcing them to resort to alternative funding sources and to shrink the size of their balance sheets.
Second, BIS data show that international interbank funding for euro area banks has collapsed from the high levels observed in 2008. This renationalisation applies especially to funding provided by euro area banks to other euro area banks. As a result, a bank’s country of origin largely determines its access to various funding instruments and their costs instead of its financial strength. These difficulties have been most pronounced for banks from peripheral countries, which have suffered the most severely from fiscal imbalances.
Third, a particular class of international institutional investors, US money market mutual funds, has on balance over the past year withdrawn large sums of short-term funding from euro area banks. For these institutional investors, however, it is not so much a case of a return to home bias as a shift from euro area and UK banks to other foreign banks.
Fourth, the crisis has led to a growing recourse to funding secured by collateral, such as covered bonds. This development adds to the already growing demand for assets with high liquidity and low credit risk, in the aftermath of the 2007–09 global financial crisis. Meanwhile, changes in regulation are adding to demand for such assets even as the loss of creditworthiness of sovereigns is reducing the number of suppliers. This has raised concerns about a potential scarcity of “safe” assets that can be used as collateral. In addition, the fact that a larger part of bank assets is used as collateral for covered bonds tends to raise the riskiness of unsecured debt, leading investors all the more to demand that debt be collateralised.
Finally, the renationalisation of bank funding has intensified the dependence on ECB liquidity, which has substituted for lost access to euro area cross-border interbank and bond funding.
Also some of these market trends were analysed: first the adverse feedback between sovereigns and banks is sketched. Then this article concentrates on the dynamics of several main sources of funding, namely international interbank markets (mostly for loans but also for bond holdings), US money market funds, bond markets and ECB liquidity.