What are the risks associated with short-term wholesale funding?

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Short-term wholesale funding

Short-term wholesale funding refers to a bank’s use of short-term deposits from other financial intermediaries—like pension funds and money market mutual funds. It uses the short-term deposits to invest in longer-term assets—like loans to businesses.

Using these short-term funds to invest in longer-term assets causes a timing mismatch between assets and liabilities. Short-term wholesale funding can be withdrawn at short-notice. Long-term assets usually aren’t as liquid.

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When short-term creditors withdraw these funds in large quantities, it can result in bank-runs. It can also result in rushed or fire-sales of long-term assets. The long-term assets are below their intrinsic values in order to fund the withdrawals. Bank-runs cause widespread panic in financial markets. This results in volatility in stock (SPY) (QQQ) and high-yield (JNK) bond indices.

The 2008 financial crisis was a classic example of wholesale funding risks. After the Lehman Brothers collapse in September 2008, Wachovia lost ~$5 billion in deposits—or 1% of its total deposits—on September 26, 2008. This was mainly due to wholesale depositors withdrawing funds. This raised concerns among regulators that the bank wouldn’t have enough funding to open for business after the weekend.

Wachovia was quickly put up for sale over the weekend. It sold to Wells Fargo (WFC) for ~$15 billion. WFC is one of Berkshire Hathaway’s (BRK-B) “Big-Four” investments. BRK-B is the largest shareholder in the lender.

Daniel Tarullo’s take on short-term wholesale funding risks in his testimony to the Senate

“Short-term wholesale funding plays a critical role in the financial system. During normal times, it helps to satisfy investor demand for safe and liquid investments, lowers funding costs for borrowers, and supports the functioning of important markets, including those in which monetary policy is executed. During periods of stress, however, runs by providers of short-term wholesale funding and associated asset liquidations can result in large fire sale externalities and otherwise undermine financial stability.”

In the next part of the series, we’ll discuss the measures that the Fed and other agencies took to reduce these risks.

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