Spillovers of funding dry ups

Focus

Dry-ups in funding markets often lead to financial crises, with adverse macroeconomic consequences. Understanding their dynamics is important. However, isolating the effect of a funding dry-up from broader crisis effects is a challenge for empirical research, as they usually go hand-in-hand. 

In this paper, we study the dynamics of funding dry-ups by exploiting a policy reform that resulted in a wholesale funding shortfall in only one market during an otherwise tranquil period.

Contribution

We uncover a new channel for spillovers of funding dry-ups. When banks face a funding shortage in one market, intensified competition for funds make the effects felt in other funding markets and for other banks as well. The group of banks affected only through spillovers can ultimately suffer the most, raising concerns about their ability to exploit profitable lending opportunities.

Findings

The 2016 US money market fund (MMF) reform exogenously reduced unsecured MMF funding for some banks. We use novel data to trace those banks to a platform for corporate deposit funding. We show that intensified competition for corporate deposits spilled the funding squeeze over to other banks with no MMF exposure. These banks paid more for deposits, and their pool of funding providers deteriorated. Moreover, their lending volumes and margins declined and their stocks underperformed. Nevertheless, we find no material change in their riskiness.

Abstract

We uncover a new channel for spillovers of funding dry-ups. The 2016 US money market fund (MMF) reform exogenously reduced unsecured MMF funding for some banks. We use novel data to trace those banks to a platform for corporate deposit funding. We show that intensified competition for corporate deposits spilled the funding squeeze over to other banks with no MMF exposure. These banks paid more for deposits, and their pool of funding providers deteriorated. Moreover, their lending volumes and margins declined, and their stocks underperformed. Our results suggest that banks' competitiveness in funding markets affect their competitiveness in lending markets.

JEL codes: G21, G28

Keywords: funding dry-ups, competition, spillovers, money market funds, corporate deposits, dollar funding