The US Dollar Funding Premium of Global Banks

70 Pages·2016·1.27 MB·English

The US Dollar Funding Premium of Global Banks
Warren B. Hrung
Bank for International Settlements and Federal Reserve Bank of New York
Asani Sarkar
Federal Reserve Bank of New York
Abstract
Following the financial crisis of 2007, many global financial firms faced difficulties in
borrowing U.S. dollars (USD). We estimate the premium global banks paid to obtain USD (the
“USD basis”) by the rate banks pay to swap euros into USD in the foreign exchange (FX)
market, while fully hedging the FX risk, relative to the interbank rate for borrowing USD. We
find that the bank basis is higher the day following increases in CDS prices and asymmetric
information measures. Controlling for fundamental risk, the basis is lower the day after
successful borrowing at the Fed’s dollar liquidity facilities and it is higher for European banks
following an unanticipated decrease in repo funding amounts, implying that USD funding
constrains were binding for European banks during the crisis. Our results show that increased
asymmetric information and “repo runs” (through unanticipated withdrawals of repo funding)
combined to increased bank funding costs during the crisis.
We thank Viral Acharya, Adam Copeland, Itay Goldstein, Robin Greenwood, Arvind Krishnamurthy, Antoine
Martin, Martin Oehmke, Suresh Sundaresan and Wei Xiong for valuable comments. We thank Adam
Biesenbach, Parinitha Sastry and Samantha Smith for excellent research assistance. The views stated here are
those of the authors and do not necessarily reflect the view of the Bank for International Settlements, the
Federal Reserve Bank of New York, or the Federal Reserve System.
1
Following the financial crisis of 2007, many global financial firms faced difficulties in
borrowing U.S. dollars (USD) (McGuire and Von Peter, 2009). Responding to pressures in the
dollar funding markets, the ECB and other central banks provided emergency dollar liquidity to
European banks. Banks’ USD funding problems are of concern since they may lower real
investments, as firms sell dollar-denominated assets and reduce lending activities, or increase
costs to their borrowers (Acharya, Afonso and Kovner (2012)).1
In this paper, we provide estimates of the premium global banks paid from 2007 to 2011
to obtain USD in the offshore markets relative to borrowing dollars directly, and examine the
cross-sectional determinants of the USD funding premium. To be specific, we estimate the rate
banks pay to swap euros into USD in the foreign exchange (FX) market, while fully hedging the
FX risk, relative to the interbank rate for borrowing USD. According to Covered Interest Parity
(CIP), the USD funding premium (or “basis”) should be zero if arbitrage works.2 We show that
the basis, while tiny pre-crisis, has been consistently large and positive since the crisis, especially
after the bankruptcy of Lehman Brothers and again during the recent European debt crisis.
Moreover, the cross-sectional dispersion in the basis (the focus of this paper) was narrow during
normal times and widened during the subprime and European crises.
Using dynamic panel regressions, we show that the bank basis is significantly related to
fundamental risk in the cross-section. In particular, the bank basis is higher when, on the prior
day, there are higher CDS prices, more asymmetric information (i.e. higher bid-ask spread on the
1See“BankDeleveragingRisksExportingEurope'sSlump,”WallStreetJournal,November172011.
2Priortotherecentfinancialcrisis,empiricalevidencewasgenerallysupportiveoftheCIPforthedeveloped
countries,exceptwhenexchangecontrolsimpededthefreeflowofcapital. ObservedCIPdeviationstendedtobe
short-lived(11minutesorless)andwerenot,onaverage,profitmaking(Akram,RimeandSarno(2008)).Holmes
andSchott(1965)discusshowsevereexchangecontrolrestrictionsresultedinpersistentCIPdeviationsduringthe
early1930stothelate1950s. FrankelandLevich(1977)compareCIPdeviationsintranquilandturbulenttimes.
2
bank’sstock)anddecreasedliquidity(i.e.lower equityturnover). Incontrast,riskmeasures are
notsignificantinthepre-crisisperiod. Gortonand Ordonez(2012)discuss howadverse
selectionarises endogenouslyduringcrisisperiods.Forbanks, adverseselectionissues(dueto
greateruncertaintyabout itsbalancesheet,forexample)weresalientduringthecrisis(Duffie
(2010)). OurresultsshowthatFXswapsdealers chargedbanksahigherpremiumforborrowing
dollarswhenasymmetricinformationincreased,consistentwithAkerlof(1970).3
INSERT FIGURE1HERE
Weinvestigatetwomeasuresoffundingconstraints:theeffectsofunanticipatedchanges
inTripartyrepo(TPR)fundingamountsandofborrowingfrom FederalReserve(“Fed”)dollar
liquidityfacilities. Reposwereimportantfundingsourcesforoursamplebanks,amountingtoan
averageof24percentoftheirshort-termborrowingsduringthecrisis. ForEuropeanbanks,in
particular,reposwereamorereliablesourceofdollarfundingduringthecrisisthanunsecured
fundingsuch asCertificatesofDeposits(CD)and commercialpaper(CP). Figure1plotsthe
shareofCD,CPandrepoissuedbyEuropeanbanks,asapercentoftotal assetsunder
managementofthe10largestUSmoneymarketmutualfunds(MMFs),whoarethemain
purchasersofthesesecurities(Baba,McCauleyandRamaswamy(2009)). Figure1showsthat
whiletheshareofCDandCPfellduringthecrisis,theshareofrepoincreased. Oursample
banksalsoborrowedfrequentlyand extensivelyfromfiveFedliquidityfacilities.
Wefindthatthebankbasisishigherfollowingan unanticipateddecreaseinitsTPR
fundingamounts,inparticularforEuropeanbanks,anditislowerthedayafterborrowingatFed
liquidityfacilities.These resultsholdevenaftercontrollingforfundamental risk,implyingthat
3Heider,HoerovaandHolthausen(2009)examinetheeffectofadverseselectionininterbankmarkets. Asymmetric
informationcouldalsoresultinFXswapdealersreducingtheswaptenor(Flannery(1986),Diamond(1991)and
Berger,Espinosa-Vega,FrameandMiller(2005)).Inordertoobtainfinancingatthesameoriginalmaturity,banks
mayneedtocompensateswapdealersbypayingahigherpremium.
3
bankfundingcostsrespondedinparttolendingdecisions. Notably,theprobabilityofborrowing
hasalesssignificanteffectontheUSDbasisthan thequantityofborrowing,suggestingthat
constrainedsupplyofdollarswereakeyreasondrivingthebasishigher, consistentwithBottazi,
Luque,PasoaandSundaresan(2012).4 Banks faced“runs”astheycouldnotrollovertheir
short-termfunding,norofferenoughcollateraltolenders(GortonandMetrick(2010),Martin,
Skeie,andvonThadden (2010)). Fedliquidityoffsetthedeclineinrepofunding(consistentwith
Krishnamurthy,NagelandOrlov(2011))andloweredbankfundingcosts.
OurresultshighlighttheimportanceofrepofundingagainstliquidAgencycollateralthat
constituted60percentofrepofundingforoursamplebanks,amountingto $600billionof
fundingperday(and$800billionperdayduringthesubprimecrisis). Wefindasignificant
negativerelationbetweenthebasisandpriorunanticipatedrepofundingagainstAgency
collateral. WhilerepofundingagainstilliquidABScollateralalsoimpactedthebasis,it
amountedtojustover2percentofrepo fundingforoursamplebanks. Gorton(2010)and
GortonandMetrick (2010)discussthescarcityofliquidcollateralduringthecrisis.
Sincetheresultsdepend onsurvey-based LiborandEuriborrates,theintegrityofsurveys
maybeofconcern. Inparticular,ifunder-reportingofratesis greaterforUSD Liborcompared
toeuro LibororEuriborrates,thenthebasiscouldbepositiveevenintheabsenceofaUSD
fundingpremium(seeequations3aand3b).5 Regulatorshaveinvestigated Barclaysand found
thatmisreportingofrates occurredduetoadesiretoprofitfromOTCderivativespositions
(resultinginbothunder-andover-reportingofrates)andtomanagepublicperceptionsabout
4Bottazzietal(2012)showthatifdollarscannotbe“overdrawn,”thenthebasisdependsonthemarginalvalueof
possessingdollarstodayratherthantomorrow.
5Symmetrically,greaterover-reportingofeuroLibororEuriborratesrelativetoUSDLiboralsoresultsinapositive
basis.
4
banks’liquidity(resultinginunder-reportingofrates).6 Whetherthecombinedeffectresultedin
under-orover-reportingofrates,andwhetherthis was greaterforUSD Liborthaneuro Liboror
Euribor,isunclear.Wemitigatetheeffectofreportingbiasesbyusingchangesinthebasis,
ratherthanitslevel.7Wealsousetimefixedeffectsinourpanelanalysis. Thus,ifthereporting
biasisconstantovertimeorifbiaschangesareunrelatedtothecross-section,thenourresultsare
unaffected.Toaddressconcernsthatbiaschanges mayco-varywiththecrosssection,weshow
therobustnessofourresultsfordifferentpanelsofbanks.Finally,sinceBarclayshas
acknowledgedunder-reportingits Liborrates from2007toearly2009 (footnote6),weanalyze
thisperiodseparatelyandafterexcludingBarclays,andfindourresultsqualitativelyunchanged.
Howmuchdoourresultsgeneralize, giventhesmallcross-section(i.e.16 banks)? Our
samplebanksarelarge(averagemarketvalueof$83billion),systemicallyimportantinstitutions.
Duringthesampleperiod,theyaccountedfor90percentoftheTPRmarket andbetween30and
70percentofborrowings fromfourmajorFedliquidityfacilities. Moreover,asmembersofthe
LiborandEuriborpanels,andwith13ofthe16banksbeingnon-US,thesamplebanksaremajor
playersintheoffshoreUSDfundingmarkets. Therefore,understandingthesebanks’ fundflows
providesanimportantwindowintoUSDfundingactivitiesduringthecrisis.
WecontributetotheliteraturebylinkingbanklevelestimatesoftheUSDfunding
premiumandtoasymmetricinformation(Akerlof(1970),Flannery(1986), Diamond(1991)).
Weshowthehighfrequencyrelationshipofbanklevelfundingshocks,marketliquidityand
fundingcosts(GrombandVayanos(2002),BrunnermeierandPedersen(2009)).
Theremainderofthepaperisorganizedasfollows. Wereviewtherelatedliteraturein
6SeeCFTCDocket12-25andFSAfinalnoticetoBarclays,FSAReferenceNumber122702.
7Tobeprecise,wetakethedifferencebetweenthebasisanditslagtimestheautocorrelation.Sincethe
autocorrelationis0.95,theprocedureeffectivelyresultsinworkingwithchangesinthebasis.
5
Section I. InSection II, weprovidebackgroundtotheUSDfundingproblemofglobalbanks. In
Section III,wedescribeourmethodologyanddata,andprovideestimatesofthebankbasis. In
sections IVandV, wediscussthecross-sectional relationofthebankbasiswithfundamentalrisk
andfundingrisk,respectively. InsectionVI, wereportestimatesofthetimefixedeffectsfrom
thepanelregressionsand relatethemtocrisiseventsandpolicyresponses. Sub-periodanalysis
ofdifferent LiborbankpanelsisinSectionVII. SectionVIIIconcludes.
I. Related Literature
PriorliteratureonCIPviolationsfocusesonaggregate,ratherthanbanklevel,measures
ofthebasisanditscontemporaneousrelationtocreditandliquidityriskmeasures (Babaand
Packer(2008),Coffey, HrungandSarkar(2009), andGriffoliandRanaldo (2011)).Unlikethese
papers,weprovideacausallinkbetweenUSDfundingconstraintsandthebasisbyexamining
howbanklevelfundingsubsequentlyaffectsthebasis(therebyavoidingendogeneitybiases).
Acharyaetal(2012)and Krishnamurthyetal(2011)examinefundingofglobalbanksin
privatemarketsandincentralbankfacilities.8 Wecomplementtheseanalysesbyinvestigating
whetherbanks’fundingconstraintswerebinding,resultinginhigherbank fundingcosts.
Differentfromthesepapers,weusedaily(ratherthanquarterly)datawhichallowsusto
investigatedailyrepoandcentralbankborrowings(suchasfromthePrimaryDealerCredit
Facility(PDCF)). Thedailydatarevealspersistenceofrepoborrowingandthesignificanceof
unanticipatedfundflows(totalrepofunding,incontrast,doesnotaffectthebasis). Similarto
thesepapers,weshowthattheABSandCPmarketsweresourcesoffundingriskduringthe
crisis. Forexample,wefindthatbasisisnegativelyrelatedtounanticipated repofundingagainst
8Acharyaetal(2012)examinedepositsandFederalHomeLoanBanksadvances,andcomparefundingmodelsof
USandforeignbanks.Theyshowtheeffectofbanks’fundingpatternsontheirsyndicatedloanpackages.
Krishnamurthyetal(2011)examinetheTPRmarketandreposofsecuritylenders.
6
ABScollateral,animportantfundingsourceforEuropeanbanks (Bottazietal2012). Moreover,
the“common”componentofbank’sUSDfundingrisk(i.e.thetimefixedeffectestimate)is
significantlyhigheron ABCPcrisisdates. Finally,weshowthattheUSD basiswaslowerafter
issuesofCPandABCPbybankstotheFed’sCommercialPaperFundingFacility(CPFF).
Copeland,MartinandWalker(2010)alsoexamineTPRdataandfindthat theamountof
repofundingandhaircut werestableduringthecrisis.Wefocusondailyvariationsin
unanticipatedrepo fundingand relatethemtosubsequentchangesinfundingcosts.Wedonot
examinehaircutsbecause,asCopelandetal(2010)note,theyarenotnegotiatedatthetrade
level,andsoareunsuitableforhighfrequencyanalysis.Ouremphasisonthequantity,rather
thantheprice,ofrepo collateralisconsistentwithGortonandOrdonez(2012).
CetorelliandGoldberg(2011)findthatgeographicallydiverse globalbanksactivate
internalcapitalmarkets whenfacedwithfundingshocks,movingfundsbetweenlocations
dependingontheirimportanceas fundingpools.Suchliquiditymanagementwouldeasefunding
constraintsandloosenthelinkbetweenfund flowsandfundingcoststhatwefindinthispaper.
Ourresultsarerelatedto theliteratureon“limitstoarbitrage.”Onestrand oftheliterature
focusesontheroleoffundingconstraintsinlimitingarbitrage,9whileanotherstrandexamines
theroleofriskyarbitrage.10 Ourfindingsshowthatbothfundamentalriskandfunding
constraintscontributedto violationsoftheCIPrelation.
9ShleiferandVishny(1997)showhownegativeshocksareamplifiedifinvestorswithdrawmoneyfromfunds.
GrombandVayanos(2002)showthatmargin-constrainedarbitrageurs,facedwithcapitalscarcity,liquidatetheir
positionsandwidenpricediscrepancywhenhitwithanegativeshock.Geanakoplos(2003)derivemargin
constraintsendogenouslyandshowstheoptimalityofmargindebtcontracts.BrunnermeierandPedersen(2009)
studythefeedbackeffectsbetweenmarginsandmarketconditions.BasakandCroitoru(2006)andGarleanuand
Pedersen(2009)showthat,inequilibrium,thebasisbetweenanassetandaderivativeisnon-zeroifinvestorsare
heterogeneousandfaceinvestmentrestrictions.
10ShleiferandSummers(1990)arguethatsmalldeviationsfromfundamentalsmaynotbecorrectedwhencash
flowsarerisky.
7
II. Dollar Funding Crisis of Global Banks and PolicyResponses: Background
Inthepastdecade, global bankshadbuiltupsizableU.S.dollarassets,amountingto3.2
trilliondollarsattheendof2010Q4forbanksintheeuroarea(ECB(2011)). Thegrowthin
dollarassetswas, amongotherthings,duetoincreasedinvestmentsinUSD-denominated
structuredfinancialproducts,and greaterUSDlendingtofirms.
Mostglobalbanksmeettheirdollarfundingneeds byissuingUSD-denominated
wholesaledebt,such as CDandCP,outofU.S.bankbranchesandothercorporateentitiesthat
donotbenefitfromFederaldepositinsurance. Duringcrisisperiods,wholesaledebtinvestors
suchasU.S.MMFsmay“runon”unsecureddebt, asoccurredduringthesubprimecrisisand
againduringtheEuropeandebtcrisis(Figure1).Europeanbanksmaybridgetheir“dollar
fundinggap”bydeleveraging(forexample,bysellingassetsorreducinglending),andby
borrowingdollarsthroughtheirU.S.branchesfromtheFed’sliquidityfacilities. Theeffecton
thebasisofborrowingfromfiveFed facilities,andfromtherepomarket,isstudiedinSectionV.
Themostwidelyused USDfundingsourceforglobalbanksistheFXswapmarketwhere
theyconverttheirdomesticcurrencyliabilitiesintodollarsforafixedperiodoftime(Fenderand
McGuire(2010)). Forexample,Europeanbankscouldissueeuro-denominateddebtandthen
swaptheeurosintodollarsatthegoingexchangerate,whileagreeingto exchangethose
currenciesbackinthefutureattheforwardrate. Thecostofusingtheseswapsisgivenbythe
euro-USDpremiumorbasisthatweestimateinthispaper.
In responsetodollarfundingstrains,theFed,incoordinationwithothercentralbanks,
putinplacecentralbank liquidityswapsinDecember2007.11 Thefacilitywasshutdownin
11Underthesearrangements,theFedprovidesdollarsinexchangeforanequivalentamountofforeigncurrency
basedonprevailingmarketexchangeratesforapredeterminedperiod. Theforeigncentralbankmakesdollarloans
tobanksinitsjurisdiction. Sincethisprovisionofdollarsisintermediatedthroughtheforeigncentralbank,it
minimizescreditriskfortheFed. Seehttp://www.federalreserve.gov/monetarypolicy/bst_liquidityswaps.htm
8
February2010but,asdollarfundingstrainsfrom theEuropeandebtcrisisincreased,itwas
reintroducedinMay2010.Toencourageusage,theFed andothercentralbanksreducedthe
borrowingrateonthedollarliquidityswapsby50 basispointsonNovember30,2011.12 The
amountoutstandingattheswapfacilitypeaked at almost$600billioninDecember2008 andwas
about$109billioninJanuary2012.Theeffectofthesecentralbankinterventionsonthetime
seriescomponentofthepanelofbankbasisisexaminedinSectionVI.
INSERT FIGURE2HERE
Figure2providesaschematicrepresentationoftheUSDfundingflowsofaglobalbank
withprimarilyeuro-denominateddeposits.Fundflowsareinblue. Fundamentalrisk(red arrow)
affectsthefundingterms. Theremainingpartsofthepaperestimatetherelationshipsbetween
bankfundamental risk,USDfundflowsandtheUSDbasisusingdailydata.
III. Data, Methodologyand Estimates of the Bank Basis
Wedescribethedataand themethodologyforestimatingtheUSDbasisin SectionAand
presentestimatesofthebasisinSectionB.Theempiricalmethodologyforestimatingthe
determinantsofthebasis isthenpresentedinSectionC.
A. DataandMeasurement
Lets bethespotrateandftheforward rateintheFXmarkets.Further, (cid:1861)(cid:3005) isthedomestic
(cid:3036)
interestrateand (cid:1861)(cid:3007) theforeigninterestrateforbank iattimet. Interestrates areinnominal
(cid:3036)
units. Exchangeratesareinunitsofdomesticcurrencyperunitofforeign currency. TheCIP
relationstatesthatforbankiattimet:
f (cid:11) (cid:12)
1(cid:14)iD (cid:32) t 1(cid:14)iF (1)
it s it
t
12Seehttp://www.federalreserve.gov/newsevents/press/monetary/20111130a.htm.
9
Givendataontheforwardrate,thespotrateandtheforeigninterestrate(cid:1861)(cid:3007),theimplied
(cid:3036)
rateisthevalueof(cid:1861)(cid:3005) thatsolves(1). Takingcountry“D”astheUS,wedefinetheUSDbasisas
(cid:3036)
thedifferencebetweentheCIP-impliedUSDrateandabenchmarkunsecuredUSDinterestrate.
f (cid:11) (cid:12) (cid:11) (cid:12)
Basis (cid:32) t 1(cid:14)iF (cid:16) 1(cid:14)iUSD (2)
it s it it
t
Inthispaper,theUSDinterestrateis assumedtobethe3-monthUSD Liborrateandthe
exchangerates aretheeuro-USDspotrateand3-monthforwardrate.Theeurointerestrateis
assumedtobeeitherthe3-montheuro Liborrateorthe3-monthEuriborrate:
(cid:3032)(cid:3048)(cid:3045)(cid:3042)(cid:2879)(cid:3022)(cid:3020)(cid:3005)(cid:3)(cid:3033)(cid:3042)(cid:3045)(cid:3050)(cid:3028)(cid:3045)(cid:3031)(cid:3)(cid:3045)(cid:3028)(cid:3047)(cid:3032)
(cid:1838)(cid:1828)(cid:1827)(cid:1845) = ((cid:883)(cid:3397)(cid:1857)(cid:1873)(cid:1870)(cid:1867)(cid:3)(cid:1838)(cid:1861)(cid:1854)(cid:1867)(cid:1870) )(cid:3398)((cid:883)(cid:3397)(cid:1847)(cid:1845)(cid:1830)(cid:3)(cid:1838)(cid:1861)(cid:1854)(cid:1867)(cid:1870) ) (3a)
(cid:3036)(cid:3047) (cid:3036)(cid:3047) (cid:3036)(cid:3047)
(cid:3032)(cid:3048)(cid:3045)(cid:3042)(cid:2879)(cid:3022)(cid:3020)(cid:3005)(cid:3)(cid:3046)(cid:3043)(cid:3042)(cid:3047)(cid:3)(cid:3045)(cid:3028)(cid:3047)(cid:3032)
(cid:3032)(cid:3048)(cid:3045)(cid:3042)(cid:2879)(cid:3022)(cid:3020)(cid:3005)(cid:3)(cid:3033)(cid:3042)(cid:3045)(cid:3050)(cid:3028)(cid:3045)(cid:3031)(cid:3)(cid:3045)(cid:3028)(cid:3047)(cid:3032)
(cid:1831)(cid:1828)(cid:1827)(cid:1845) = ((cid:883)(cid:3397)(cid:1831)(cid:1873)(cid:1870)(cid:1861)(cid:1854)(cid:1867)(cid:1870) )(cid:3398)((cid:883)(cid:3397)(cid:1847)(cid:1845)(cid:1830)(cid:3)(cid:1838)(cid:1861)(cid:1854)(cid:1867)(cid:1870) ) (3b)
(cid:3036)(cid:3047) (cid:3036)(cid:3047) (cid:3036)(cid:3047)
(cid:3032)(cid:3048)(cid:3045)(cid:3042)(cid:2879)(cid:3022)(cid:3020)(cid:3005)(cid:3)(cid:3046)(cid:3043)(cid:3042)(cid:3047)(cid:3)(cid:3045)(cid:3028)(cid:3047)(cid:3032)
ArbitrageshouldensurethattheimplieddollarrateisequaltotheactualUSDrate,so
thatthebasisiszeroandCIPholds. Anon-zerobasisinnormaltimesislikelyduetotemporary
mispricingsthatarenotarbitragedaway(Akrametal(2008)). Greaterunder-reporting(orless
over-reporting)ofUSDLiborrelativetoeuro LibororEuriborratesmayalsoresultinaspurious
non-zerobasisthatwemitigatebyusingchangesinthebasis,byusingtimefixedeffectsinthe
panelregressions,bycheckingrobustnessfordifferentbankpanelsandin differentsub-periods.
OursampleconsistsofbanksthataresimultaneouslymembersoftheUSD Liborand
euro Liborpanels,ortheUSD LiborandEuriborpanels.16banksarecommonmembersofthe
USD Liborandeuro Liborpanels,and11ofthese16banksarecommonmembersoftheUSD
LiborandEuriborpanels.Detailsofpanelbanknamesandchangesinthepanelcompositionare
inAppendix A,whichalsocomparestheLiborandEuribormechanismswithrespecttopanel
bankselection,ratesubmissionandratecalculation.