Does wholesale funding make your financial life safer or riskier? What are the advantages of wholesale funding and what are the hazards of wholesale funding? If you have not been keeping up with the banking news, wholesale funding is how many large banks are now financing their operations and managing banking risk. The traditional means of running a bank is to offer depositors a decent rate of interest to get them to put their money in the bank. Then the bank offers loans at an acceptable and profitable rate of interest, using the money from depositors. Banks have traditionally needed to maintain a currency reserve. This is to protect depositors in case of problems in the bank loan portfolio. When the banking system nearly collapsed in 2008 and 2009, badly constructed loan portfolios hemorrhaged losses and the United States government stepped in with billions of dollars in loans. Along the way credit still dried up and loans for the common person became hard to find. People lost their homes as banks foreclosed. The Federal Reserve has pursued a policy of low interest rates to help stimulate the economy. However, the same low interest rates that help industry leave savers with virtually no return on bank deposits. Savers have to choose between investing in risky stocks or other questionable investments and accepting a negligible return on their banked assets. What banks did next leads to the hazards of wholesale funding.
Wholesale Funding Sources
Banks that cannot attract enough deposits look for Federal funds, state and municipal funds, advances from the Federal Home Loan Bank, primary credit advances from the U.S. Federal Reserve, deposits from foreign sources, brokered deposits, or money from CD listing services or via the internet. The hazards of wholesale funding are that if this backup system of bank reserves does not work a banking system collapse may be in the works. Fundamental analysis of this way of doing business may lead investors to seek more secure ways to protect their assets.
Federal Deposit Insurance
The most recent increase passed by congress insures bank deposits up to $250,000 per depositor. However, the reserves of the Federal Deposit Insurance Corporation may not be sufficient in the case of a major collapse. Although the FDIC says that deposits are backed by the full fair and credit of the government, a few billion in cash plus the ability to borrow $500 billion might not be enough in the situation gets really bad. And, it is not clear to what degree the government would step in if FDIC resources are breached.
Concerns Voiced by the FED Chairman
In a recent speak Fed chairman Bernanke noted that important risks remain in the short-term wholesale funding markets. His concern is how the system at large would respond to the failure of a single broker-dealer or borrower. The sense of this and the hazards of wholesale funding are that credit is to a large degree maintained by accessing other credit. The Federal Reserve is doing continual stress testing to see how the financial system would respond to various stresses. And, according to the Fed chairman, more work is needed to better prepare investors and other market participants to deal with the potential consequences of a default by a large participant in the repo market. He said this in the context of a possible run on money market funds.
Where Else Can You Invest or Save Your Money?
We wrote some time ago about three good offshore investment ideas. Although it may not be time yet to pack up and leave the good old USA, it may be time to look at investing in foreign stocks, or looking for real estate in growing markets like Panama, Colombia, and Brazil where the hazards of wholesale funding are something that you read about in the international edition of the Miami Herald but do not affect your every day or financial life.