A New Indicator of Bank Funding Cost

Eric Jondeau, Benoit Mojon and Jean-Guillaume Sahuc

No 20-20, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: The cost of bank funding on money markets is typically the sum of a risk-free rate and a spread that reflects rollover risk, i.e., the risk that banks cannot roll over their short-term market funding. This risk is a major concern for policymakers, who need to intervene to prevent the funding liquidity freeze from triggering the bankruptcy of solvent financial institutions. We construct a new indicator of rollover risk for banks, which we call the forward funding spread. It is calculated as the difference between the three-month forward rate of the yield curve constructed using only instruments with a three-month tenor and the corresponding forward rate of the default-free overnight interest swap yield curve. The forward funding spread usefully complements its spot equivalent, the IBOR-OIS spread, in the monitoring of bank funding risk in real time. First, it accounts for market participants' expectations of how funding costs will evolve over time. Second, it identifies liquidity regimes, which coincide with the levels of excess liquidity supplied by central banks. Third, it has much higher predictive power for economic growth and bank lending in the United States and the euro area than the spot IBOR-OIS, credit default swap spreads or bank bond credit spreads.

Keywords: Bank funding risk; bank credit spreads; liquidity supply regimes; multi- curve environment; economic activity predictability. (search for similar items in EconPapers)
JEL-codes: E32 E44 E52 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2020-04
New Economics Papers: this item is included in nep-ban and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2020

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