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The Effect of Monetary Policy on Bank Wholesale Funding This article was downloaded by: [137.68.212.128] On: 02 November 2020, At: 21:33 Publisher: Institute for Operations Research and the Management Sciences (INFORMS) INFORMS is located in Maryland, USA Management Science Publication details, including instructions for authors and subscription information: http://pubsonline.informs.org The Effect of Monetary Policy on Bank Wholesale Funding Dong Beom Choi, Hyun-Soo Choi To cite this article: Dong Beom Choi, Hyun-Soo Choi (2020) The Effect of Monetary Policy on Bank Wholesale Funding. Management Science Published online in Articles in Advance 20 May 2020 . https://doi.org/10.1287/mnsc.2019.3463 Full terms and conditions of use: https://pubsonline.informs.org/Publications/Librarians-Portal/PubsOnLine-Terms-and- Conditions This article may be used only for the purposes of research, teaching, and/or private study. Commercial use or systematic downloading (by robots or other automatic processes) is prohibited without explicit Publisher approval, unless otherwise noted. For more information, contact [email protected]. The Publisher does not warrant or guarantee the article’s accuracy, completeness, merchantability, fitness for a particular purpose, or non-infringement. Descriptions of, or references to, products or publications, or inclusion of an advertisement in this article, neither constitutes nor implies a guarantee, endorsement, or support of claims made of that product, publication, or service. Copyright © 2020, INFORMS Please scroll down for article—it is on subsequent pages With 12,500 members from nearly 90 countries, INFORMS is the largest international association of operations research (O.R.) and analytics professionals and students. INFORMS provides unique networking and learning opportunities for individual professionals, and organizations of all types and sizes, to better understand and use O.R. and analytics tools and methods to transform strategic visions and achieve better outcomes. For more information on INFORMS, its publications, membership, or meetings visit http://www.informs.org MANAGEMENT SCIENCE Articles in Advance, pp. 1–29 http://pubsonline.informs.org/journal/mnsc ISSN 0025-1909 (print), ISSN 1526-5501 (online) The Effect of Monetary Policy on Bank Wholesale Funding Dong Beom Choi,a Hyun-Soo Choib a SNU Business School, Seoul National University, Seoul 08826, Korea; b College of Business, Korea Advanced Institute of Science and Technology, Seoul 02455, Korea Contact: [email protected], https://orcid.org/0000-0002-1878-3942 (DBC); [email protected], https://orcid.org/0000-0001-6970-4338 (H-SC) Received: December 20, 2017 Abstract. We study how monetary policy affects the funding composition of the banking Revised: March 19, 2019; July 18, 2019 sector. When monetary tightening reduces the supply of retail deposits, banks attempt Accepted: July 25, 2019 to substitute wholesale funding for deposit outflows to smooth their lending. Because of Published Online in Articles in Advance: financial frictions, banks have varying degrees of access to wholesale funding. Therefore, May 20, 2020 large banks, or those with greater reliance on wholesale funding, increase their wholesale https://doi.org/10.1287/mnsc.2019.3463 funding more. Consequently, monetary tightening increases both the reliance on and the concentration of wholesale funding within the banking sector. Our findings also suggest Copyright: © 2020 INFORMS that liquidity requirements could bolster monetary policy transmission through the bank lending channel. History: Accepted by Tyler Shumway, finance. Funding: This work was supported by the Institute of Management Research at Seoul National University and a Singapore Ministry of Education Academic Research Fund Tier 1 grant. Supplemental Material: Data and the online appendix are available at https://doi.org/10.1287/mnsc.2019.3463. Keywords: monetary transmission • bank liability • deposit • financial stability • bank lending channel • wholesale funding substitutions • cross-sectional heterogeniety • liquidity regulation 1. Introduction that increase with the size of a bank). We then discuss The recent financial crisis clearly demonstrated the the implications of the interaction between the new risks of banks being dependent on short-term whole- liquidity regulations and monetary policy, both in sale funding, as it can critically increase funding li- terms of systemic stability (focusing on risks) and the quidity risks during times of market disruption. In monetary policy transmission mechanism (focusing response to such concerns, the Basel Committee on on policy effectiveness). Banking Supervision introduced new liquidity reg- Bank borrowing can typically be divided into two ulations, such as the liquidity coverage ratio (LCR) sources: retail deposits and wholesale funding. Retail and the net stable funding ratio (NSFR), to contain deposits, sometimes referred to as core deposits or the excessive reliance on runnable funding in the core funding, represent funding from a bank’stra- banking sector. Whereas previous studies have ana- ditional and regular customer base in the local geo- lyzed the risks of relying on wholesale funding during graphic market. In contrast, wholesale funding is mostly the crisis,1 what contributed to the rapid development supplied by other financial intermediaries, such as of a reliance on wholesale funding in the banking sector money market mutual funds, and raised through the in the run-up to the crisis and how the new liquidity money market (e.g., large certificates of deposit, for- regulations will interact with existing policy measures, eign or brokered deposits, and repo funding). Retail particularly monetary policy, remain open questions. deposits have lower funding costs (Berlin and Mester In this paper, we examine the impact of monetary 1999,DeYoungandRice2004), have lower interest policy on bank funding composition, both in the time rate elasticity owing to the transactional or storage dimension and in the cross-sectional dimension. We (i.e., “monetary”) purposes of depositors (Amel and arguethatmonetarytighteningbycentralbankscon- Hannan 1999), and are more sticky with regard to tributes to the accumulation of the banking sector’s funding liquidity risks and sensitivity to financial mar- reliance on wholesale funding, as well as systemic ket conditions (Flannery and James 1984, Berlin and imbalances, in that the distribution of the reliance on Mester 1999,Cornettetal.2011,ChoiandVelasquez wholesale funding becomes more concentrated among 2016). Because the retail deposit supply is highly price heavy users or large banks. This implies that during inelastic, banks often reach out to the wholesale funding monetary tightening, a financial system could become market when they wish to expand their lending. more vulnerable in terms of funding liquidity risks We first discuss the relationship between changes and potential spillover effects (e.g., fire-sale externalities in monetary policy stances and the reliance on wholesale 1 Choi and Choi: The Effect of Monetary Policy on Bank Wholesale Funding 2 Management Science, Articles in Advance, pp. 1–29, © 2020 INFORMS fundinginthebankingsectorbymeasuringabank’s to measure the sensitivity of funding substitution to reliance on wholesale funding as the ratio of total monetary policy. Using this measure, we find that wholesale funding to retail deposits. Previous studies lending by a bank with higher funding substitution commonly suggest that monetary tightening drains sensitivity fluctuates less with changes in the mone- retail deposits from the banking sector (e.g., Bernanke tary policy stance. and Blinder 1992, Kashyap and Stein 1995)byde- Note that in our empirical specifications, we regress creasing bank reserves, which limits the creation bank-level balance sheet adjustments on changes in of (reservable) retail deposits. In addition to this the monetary policy stance. Our results may be sub- transmission channel, we focus on the variation in ject to an identification problem, as the change in the depositor’s opportunity cost of holding retail de- unobservable loan demand would be a confounding posits, which pay upward-sticky interest, if any at all factor. To mitigate this problem, we first include in (Hannan and Berger 1991, Hutchison and Pennacchi our regressions various macro- and bank-level con- 1996, Drechsler et al. 2017). trols that are related to the change in loan demand. Because of this upward stickiness, which may be Because the change in local economic conditions is banks’ optimal choice, the opportunity cost of such an important factor for the change in local loan de- “bank money” for savers increases in the policy rate, mand,wealsousethesubsampleof“local” banks that which also contributes to the decline in the supply of operate predominantly within a single metropolitan retail deposits to banks. To replace deposit outflows, statistical area (MSA), with additional MSA-level con- banks increase their reliance on alternative funding trols and find that our results are robust. sources, such as wholesale funding, to smooth their In addition, we exploit demographic variations in lending. Using quarterly panel data from the Con- the composition between senior (“old,” those aged solidated Financial Statements for Holding Compa- 65 and over) and nonsenior (“young”) depositors nies (FR Y-9C reports) and the Federal Reserve’s across regions to improve the tightness of our iden- Report of Condition and Income (call reports) be- tification. Here, our identification strategy focuses
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