Main Funding Methods Used by Banks

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  • Topic: Repurchase agreement, Bond, Bank
  • Pages : 7 (2459 words )
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  • Published : April 11, 2013
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In recent years, many banks are experiencing a decrease in the traditional deposit funding sources and thus failed to keep up with the growth in bank assets. To make up for this decrease, banks supplemented their funding with less stable and more expensive funding instruments, together with cutting back on their holdings of cash and securities and selling or securitizing parts of their loan portfolio. These have increased the challenges that banks face in maintaining stability and profitable operations. Banks Deposits

Bank deposits are the primary sources of money for banks as it includes the deposits made in a bank’s natural demographic market. Bank’s deposits are derived from banks regular customer base and are the most stable and least costly source of funding. Deposits ranges from small sources such as individual consumers saving account to large sources such as business checking and money market accounts. Banks typically make a significant portion of their income off interest and fees associated with loans and other services that are made possible by core deposits. The greater the number of customers and core deposits the banks can attract, the more its ability to loan out money and generate income. The greater a bank’s income, the bigger it can grow and more products and services it can offer. A higher core deposit boosts a bank’s performance by providing stable and predictable funding and indicates strong liquidity of a bank. The traditional deposits-based bank funding model has been under strain due to intense competition for household saving, among banks and from alternative investment institution (mutual funds, life insurance products, etc.). The current banking crisis will likely have a prolonged effect on deposits. Investors that supplied funds may have suffered a major loss in one market or may have changed their beliefs about banks (reputational risk). As a result, these investors shifted funds to low-risk assets such as Government bonds. Core deposits have a positive effect on the bank’s interest rate risk profile. It will also increase the bank’s ability to compete and retain loan customers. In order to decrease liquidity risks, banks need to increase bank deposits. Banks need to enhance the services that are available to customers. Such services nowadays include bank's deposit process by allowing customers to make electronic banking through an internet and mobile connection. Banks also need to provide convenient branch locations and flexible opening hours. This will help to retain current customers and to attract new ones. Banks also need to enhance their marketing strategies to current and prospective customers. An example of this is by offering incentives to current customers to recruit family and friends to open an account. Banks need to increase the competitive products that are offered to customers. This includes offering high yield reward and checking accounts to increase core deposits. Reward checking accounts carry higher interest rates than the traditional checking account, making them more attractive to customers. Features such as no monthly service charges and overdraft fee protection can also help to attract customers. Developing a strong core deposit base will better the banks positionfor long-term success.

Wholesale funding

Although core deposits continue to be a key liability funding source, many banks have experienced difficulty attracting these types of deposits. Therefore, in order to satisfy funding and liability management banks are increasingly looking to wholesale funding. To supplement a reduce deposit base, banks increasingly use the wholesale money market to attract liquidity surpluses of financial institutions, non financial corporations, local authorities and foreign entities. Such wholesale funds are usually raised on a short-term rollover basis with the main instruments being Certificate of Deposit market and Interbank Deposits. A Certificate of Deposit...
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