The disappearance of liquidity during the financial crisis has led banks to reappraise their funding methods, and regulatory reform may push them further towards a more resilient decentralised model, according to a report due to be released on Thursday by the Bank for International Settlements (BIS).
As a result of the crisis, banks are shifting away from using the wholesale markets for funding, and towards a combination of retail and capital market funding, the BIS Committee on the Global Financial System found. This has also meant a heavier dependence on local funding rather than cross-border funding. At the same time, liquidity management is becoming much more centralised, as banks have become more aware of the dangers of a liquidity crisis (though this awareness could fade with time, the committee warned).
The shift so far has been "marginal", the report says, but regulatory measures could push banks further towards a model of local funding. The UK Financial Services Authority decided in October 2009 to require self-sufficiency for all institutions under its aegis, including local branches of foreign banks. If this approach were carried over to other jurisdictions, it would lead to a more resilient financial industry - although increased demand for retail deposits could also increase the cost of funds for individual banks.
However, this might not be a bad thing, the committee continued: "To the extent that low wholesale market funding costs prior to the crisis had led banks to underestimate risks from maturity and currency mismatches and facilitated the rapid build-up of exposures, higher funding costs could result in more conservative asset side policies by international banks."
The change in funding strategies would also mean lower volumes on the currency markets, as banking groups moved less funds between countries, the report predicted. The effects could be harmful for countries such as the Baltic states which are highly dependent on imported capital - and equally for countries whose depositors rely on being able to seek better yields abroad. But it warned that even a highly decentralised bank could still be a conduit for contagion: the reputational damage of allowing a local subsidiary to fail could lead international banks to step in, even if there were no strictly commercial reason to do so.
This article first appeared on Risk.net