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The Dark Side of Bank Wholesale Funding

Listed author(s):
  • Huang, R.
  • Ratnovksi, L.
Registered author(s):

    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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    File URL: https://pure.uvt.nl/portal/files/1105354/2009-18S.pdf
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    Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2009-59 S.

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    Date of creation: 2009
    Handle: RePEc:tiu:tiucen:7f6c9a9c-6cae-4db4-b0bc-94fc11e91af5
    Contact details of provider: Web page: http://center.uvt.nl

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