Unveiling Wholesale Money: An Essential Guide
Wholesale money refers to the substantial sums of money lent by financial institutions in money markets. This category of wholesale banking includes markets for tradable securities such as Treasury bills, commercial paper, banker’s acceptances, foreign or brokered deposits, certificates of deposit, bills of exchange, repo agreements, federal funds, and various short-lived mortgage and asset-backed securities.
Key Takeaways
- Wholesale money constitutes large sums of money lent by financial institutions in money markets.
- It is known for being swift to arrange but fraught with potential dangers if overly relied upon.
- Wholesale money markets serve as a crucial leading indicator of financial system stress.
The Crucial Role of Wholesale Money
Wholesale money provides large corporations and financial institutions with essential working capital and short-term financing, playing a pivotal role in the smooth operation of the U.S. and global financial systems.
Although swift to arrange, wholesale funding can be perilous if excessively depended upon, as proven during the global financial crisis when the market for such funding collapsed. Banks learned the hard way that overreliance on short-term wholesale funding instead of retail deposits, combined with repurchase agreements, heightened exposure to liquidity risk when they needed liquidity the most.
Such a scenario unfolded after Lehman Brothers’ collapse during the 2008 financial crisis. Banks witnessed a run, and investors withdrew their wholesale funds, leaving institutions like Wachovia vulnerable. Losing approximately $5 billion, around 1% of its funds, Wachovia was directed by the FDIC to negotiate takeovers, culminating in its sale to Wells Fargo for about $15 billion over a weekend.
An earlier red flag emerged in 2007 when Northern Rock, a British bank dependent on wholesale markets for financing, couldn’t sustain its lending activities and had to seek emergency funds from the Bank of England.
Indicators and Risks of Wholesale Money Markets
Wholesale money markets offer a reliable leading indicator of stress within the financial system, often painting a more accurate borrowing cost picture than official central bank interest rates. Post-crisis, the Overnight Index Swap (OIS) discounted overnight rate has become an essential measure of credit risk within the banking sphere, pegged to short-term benchmark rates like the Federal Funds Rate.
The ongoing demand for high-quality liquid assets (HQLA) indicates that wholesale money markets are far from fully recovered, even as globally systemically important banks (G-SIBs) comply with robust Basel III capital and liquidity mandates - including the liquidity coverage ratio and the net stable funding ratio.
The U.S. introduced new money market regulations in 2016, yet the Federal Reserve continues to bolster market stability through its Reverse Repurchase (RRP) facility, confronting the fallback on wholesale funding triggered by rising interest rates and diminishing retail deposits, subsequently escalating systemic risk.
Related Terms: money market, wholesale banking, liquidity risk, repurchase agreement, Federal Funds Rate.
