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Home > News and Publications > News Release - Quarterly Bulletin pre-release article: ‘Bank funding costs: what are they, what determines them and why do they matter?’
 

News Release - Quarterly Bulletin pre-release article: ‘Bank funding costs: what are they, what determines them and why do they matter?’

​Like any business, a bank needs to finance its commercial activities – most notably making loans to households and firms – with some source of funding.  This article sets out the range of funding sources available to banks – such as savers’ retail deposits and wholesale borrowing from investors – and explains why the cost of banks’ funding is of central importance to both monetary and financial stability.


Using an analogy of two buckets balanced on a set of scales (shown to the right), the article explores the dynamic nature of bank funding and bank lending.  This simplified depiction of a bank’s balance sheet is used to illustrate some possible implications of an increase in banks’ funding costs for both individual firm profitability and broader macroeconomic and financial conditions.
​                                       
​“Buckets on scales” depiction
of a bank’s balance sheet
 
Banks’ funding costs are integral to the transmission of monetary policy and hence the outlook for growth and inflation. This was clearly demonstrated in the wake of the 2007-08 financial crisis:  prior to then, bank funding costs largely moved in line with ‘risk-free’ interest rates such as Bank Rate. With the onset of the financial crisis, however, many sources of funding evaporated rapidly and funding costs rose sharply relative to risk-free rates. This, in turn, put upward pressure on the lending rates faced by households and firms. 
 
Funding costs also matter for financial stability. The article explains how a rise in funding costs is likely to reduce a bank’s profitability, even if it chooses to pass on higher funding costs to customers (by charging higher interest rates on any new lending).  Over time, a reduction in profitability could erode a bank’s capital buffer, threatening its solvency and posing risks to broader financial stability.  The experience of the financial crisis also revealed how banks with weak capital positions were forced to pay more for their funding. 
 
The article concludes: ‘The article concludes: ‘looking ahead, the likely normalisation of monetary policy at some point, the introduction of new liquidity metrics and the phasing in of higher capital requirements ahead of the full implementation of the Basel III capital framework in 2019 are all likely to affect the outlook for funding costs. In time, some policies put in place during the crisis are also likely to be removed and may affect banks’ cost of funds. These examples underline why it is important for Bank staff to continue to monitor closely a wide range of measures of bank funding costs.’
 
A short video that works through some scenarios using the ‘buckets on scales’ analogy is available to view on the Bank’s YouTube channel.
 
The rest of the Q4 edition of the Bulletin will be published at 00:05 hrs on 8 December 2014.   
 
Note to Editors  
 
Copies of the Quarterly Bulletin are available from: 
Publications Group
Bank of England
Threadneedle Street
London EC2R 8AH
(Tel: 020 7601 4030; Fax 020 7601 3298) www.bankofengland.co.uk/publications/pages/quarterlybulletin/default.aspx
 

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