Bank Funding Dynamics Between Retail Deposits and Wholesale Funds: Implications for Regulations

Yi Zheng () and S. Drew Peabody ()
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Yi Zheng: State University of New York at New Paltz: SUNY New Paltz
S. Drew Peabody: Elon University

Journal of Financial Services Research, 2025, vol. 68, issue 1, No 3, 75-122

Abstract: Abstract This paper identifies a contemporaneous substitutional relationship between retail deposits and wholesale funds, while the lagged relationship between the two is rather weak-a finding consistent with our “stable capitalization hypothesis.” We find that this substitution effect is much more pronounced for banks facing retail deposit inflows compared to those facing outflows, suggesting that influxes of deposits allow banks to cut wholesale funding more aggressively to maintain their capital structures. This substitution effect is also negatively associated with wholesale funding maturity and riskiness. Furthermore, we show that the substitutional relationship is weaker during funding shocks such as the 2007-2009 financial crisis and that the substitution itself does not help banks maintain their lending, which supports the argument for a lender of last resort. Finally, we demonstrate that liquidity regulation curbs this substitution, which overall helps banks improve financial stability.

Keywords: Wholesale funding; Liquidity regulation; Lender of last resort; Financial crisis; Bank risk (search for similar items in EconPapers)
JEL-codes: E32 E44 G21 G28 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s10693-024-00423-z

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