Banks in the UK are increasing their reliance on short-term funding as rising interest rates increasingly force depositors to seek better deals outside of traditional banks.
According to a recent report from the Bank of International Settlements (BIS), at the beginning of this year UK banks saw a $50bn increase in funding from US non-banks in the first quarter of the year alongside a $43bn decline in deposits from the real economy.
The data showed UK banks were increasing their reliance on short-term funds at a faster rate than lenders in other jurisdictions.
Much of this increase came from so-called money-market funds (MMFs) based in the US.
MMFs generally offer investors higher interest rates than bank deposits, incentivising savers to move funds across to the higher-yielding asset. This money is then often recycled back into banks in the form of short-term loans.
Concerns have been raised that the increasing role of MMFs poses problems to financial stability. As BIS observed, “MMFs can be a flighty source of funding. Stronger reliance on them can thus be a source of bank vulnerabilities”.
Regulatory experts told City A.M. close attention needed to be directed to MMFs.
Lee Doyle, partner at Ashurst, said “MMF liquidity is inherently short term and liable to withdrawal. This must be considered a growing systemic risk”.
Doyle said MMFs can be a “sensible option” within a broader portfolio but insisted that lenders needed to ensure that the proportion of short-term funding remained at a manageable level.
“The source of funding is less important than the alignment of funding and lending,” he said. “The financial crisis saw a major misalignment of short-term funding and long-term lending, when short-term spikes (or withdrawals) led to the liquidity crisis.”
Anindya Ghosh Chowdhury, director at Mazars, said the limited amount of regulation in the sector posed dangers. There is a “distinct absence” of regulation, he said, which “increases the quantum of financial stability risks, especially in the current interest environment”.
Although the Bank of England is developing new tools to inject liquidity directly into non-banks, Chowdhury pointed out MMFs will not be able to access this emergency funding.
“This means that the liquidity risks and vulnerabilities will largely remain, and could arguably worsen,” he said.
The Bank of England has flagged the risks that MMFs pose, suggesting in March that they should be “resilient to outflows at least as large as those seen in the dash for cash and LDI stress events”.
It will launch a consultation paper on money market funds later this year.