Discover more from ModernFi Insights
Impact of Rising Rates
April 19, 2022 | Wholesale Funding Update
With realized inflation reaching its highest level in decades and inflation expectations rising materially, the Federal Reserve is embarking on what is likely to be an aggressive tightening cycle.
Historically, monetary policy tightening leads to a decline in retail deposits. As interest rates on retail deposits rise slower than market rates, depositors’ demand for “bank money” tends to decline as the policy rate increases. In response to this decline, banks have, in aggregate, tended to substitute into wholesale deposits to smooth their lending. Indeed, recent work from the New York Fed finds that a one percent increase in the federal funds rate has historically led to a four percent increase in wholesale funding over the following year, and a near one percent increase in banks’ reliance on wholesale funding (the ratio of wholesale funding to retail deposits). These effects are even stronger for banks that typically rely more on wholesale funding. As a result, banks that utilize wholesale deposits have been able to maintain more stable lending than their peers over monetary policy cycles.
The next several quarters in the wholesale funding market promise to be fascinating.