Global Banks, Dollar Funding, and Regulation

Revised version, March 2022

Summary

Focus

US dollar funding is the lifeblood of international banking. Non-US global banks have a very large footprint in dollar banking despite their restricted access to core dollar deposits and central bank backstops. They collectively held $12.6 trillion of dollar-denominated assets by the end of 2017 – rivalling those of US banks. Wholesale dollar funding markets, in which global banks source dollars, were at the forefront during the Global Financial Crisis (GFC) and the euro zone sovereign debt crisis. Both crises – together with subsequent regulatory reforms – have changed the structure and functioning of these markets.

Contribution

We show that pricing in the very deep and liquid market where global banks source their dollar funding is far from competitive. We use a detailed data set of US money market fund (MMF) holdings of secured and unsecured instruments issued by these banks. The richness of our data set allows us to study underlying market frictions and identify their effects on prices. Our identification strategy is based on exogenous market disruptions during otherwise tranquil periods, which helps us to avoid the impact of confounding factors usually present during a crisis.

Findings

We document persistent and significant price dislocations in these wholesale dollar funding markets. The markets for both repos and unsecured instruments are highly concentrated, with the top five US MMF fund families taking around 60% of the respective market shares. We establish the key role of bargaining frictions arising from the over-the-counter nature of these markets. To establish the causal effect of bargaining power on prices, we devise an identification strategy that utilises external shocks on both the funding supply (MMFs) and demand (banks) sides, in both secured and unsecured instruments. Disruptions in these markets can spill over to other key dollar funding markets such as foreign exchange (FX) swaps.

Abstract

We document significant and persistent price dislocations in secured and unsecured wholesale dollar funding markets between US money market funds (MMFs) and highly-rated global banks. We show that bargaining frictions affect prices in these key short-term dollar funding markets. Our identification strategy relies on a number of quasi-experiments, including the US MMF reform and quarter-end window-dressing by European banks.  Post-crisis regulations have reduced competition in these markets and have generated incentives for regulatory arbitrage, which affect bargaining power and prices. Our results also highlight substantial heterogeneity across global banks of different nationalities in their behavior in dollar funding markets.

JEL classification: G15, F30, G21, G28

Keywords: global banks, dollar funding, money market funds, relationship frictions, US Money Market Fund reform