|Researchers:||Iñaki Aldasoro, Florian Balke, Andreas Barth, Egemen Eren|
Topic & Objectives
We study the dynamics of funding dry-ups and their adverse macroeconomic consequences by exploiting a policy event that led to a wholesale funding shortfall in only one market during an otherwise tranquil period.
As the policy event in a difference-in-differences framework, we use the US Money Market Fund (MMF) reform that was implemented in October 2016. The reform was adopted in order to curb the run-prone nature of MMFs. In response, fund families converted prime funds into government funds, which, in effect, replaced the provision of unsecured funding to banks with buying government securities. The reform resulted in an aggregate loss of around 350 billion dollar in unsecured dollar funding for global banks with MMF exposure.
The reform constitutes close to an ideal setting to study channels of spillovers from a funding squeeze. In addition to taking place during an otherwise tranquil period for financial markets, it directly affected only banks that actively borrow from MMFs (which we call MMF banks). This allows for a clear distinction between MMF banks and banks with no direct exposure to MMFs (which we call non-MMF banks). Moreover, since it only affected the dollar wholesale funding of banks, the reform should only have an impact in dollar markets and not in other currencies. These features and the richness of our dataset allow us to cleanly identify spillovers, as the impact of the reform on non-MMF banks should only be through spillovers in dollar funding markets.
We combine three granular datasets to study spillovers in funding markets and their effect on bank lending. First, we identify banks that suffered a loss in dollar funding due to the reform by using transaction-level data from the regulatory filings of US MMFs. Second, we use a unique and granular dataset from one of the largest corporate deposit trading platforms located in Europe. In the platform, firms auction deposits and banks bid for them. The dataset contains bid-level information on deposit auctions in various currencies, with the largest transaction volumes in dollar, euro, and pound. Our main focus is on transactions in dollar since the reform induced a wholesale dollar funding shortage. However, we use the information on deposits in other currencies as a key robustness check, which allows us to show that spillovers occur only for banks' dollar funding. Third, we use data on syndicated loans to study changes in the lending behavior of banks in our sample.
We use an empirical design in the spirit of Khwaja and Mian (2008) to control for loan demand and compare the same firm borrowing in dollar from MMF and non-MMF banks. In this way, we rule out that potential confounding effects related to firms' demand for loans from non-MMF banks might be driving the results. On the liability side, non-MMF banks pay more for funding, and at the same time, their lending mark-ups decrease, leading to a relative decline in profit margins. Taken together, the results point to a loss of competitiveness in lending markets driven by the loss of competitiveness in funding markets.
Our paper provides new insights into corporate deposit markets using a unique and granular dataset. Despite their increasing importance and potential to lead to financial instability, data unavailability has previously hindered to study these markets. However, while our dataset provides rich information, it only covers a small segment of the market for corporate deposits. Future research using other segments of corporate deposit markets would be useful to understand these markets and how they might affect financial stability.
- We provide evidence of a new channel through which funding dry-ups spill over from one funding market to others: The 2016 money market reform in the US led to a US dollar wholesale funding dry-up in one market during an otherwise tranquil period for funding markets.
- When the US MMF reform reduced the availability of unsecured funding for some banks, they tapped into the corporate deposit markets intensifying competition with other banks with no MMF exposure.
- Initially unaffected banks had to pay higher deposit rates relative to MMF banks to retain funding and were crowded out from stable funding providers.
- We show that these effects only apply to dollar deposits. There is no effect on pound deposits around the time of the MMF reform. This suggests that the effect is driven by spillovers due to the reform.
- As a consequence, non-MMF banks lent less and at lower prices relative to MMF banks, their profit margins declined and stocks underperformed. Nevertheless, there was no material change in their riskiness.
- We show that over a 3-month horizon, stocks of MMF banks outperform those of non-MMF banks by 12-15 percentage points.
- Investors might worry about the ability of non-MMF banks to access dollar funding, causing uncertainty about their riskiness and solvency position. In this case, we would expect the CDS spreads of the two groups of banks to diverge.
- Non-MMF banks might not be able to fully exploit lending opportunities in the future, affecting the stock prices through a reduction of cash flow expectations due to the decline in the profitability of the dollar segments of their business. We find no evidence of a significant difference in 5-year CDS spreads, lending support to the cash flow channel.
Our results have three major implications for financial stability and policy. First, they highlight that different types of liabilities – such as MMF-provided wholesale funding and corporate deposits – are substitutable to some degree. It is hence important to understand the nature of this substitutability to gauge the reactions of banks in the event of a funding dry-up in one market.
Second, in an integrated but segmented financial system, shocks to one market could spill over to other markets and affect other financial institutions. As a result, these spillovers could propagate and amplify the impact of original shocks. It is therefore important for policymakers to understand the linkages between different markets and participants in each market. Finally, these spillovers show that policy reforms can reach beyond their intended impact area. Hence, policymakers should take the possibility of spillovers into account when gauging the potential unintended consequences of policy reforms.
|259||Iñaki Aldasoro, Florian Balke, Andreas Barth, Egemen Eren||Spillovers of Funding Dry-ups||2019||Financial Intermediation|