Wholesale funding is a viable base for a business 💖model in certain interest☂ rate and credit market environments.

However, it can become risky if the slope of the yield curve changes. And if credit markets seize up, meaning credit becomes less available and borrowing costs rise, problems can also arise for institutions. If both conditions change at the same time, watch ⛎out.

This article reviews some basics of wholesale funding, the ideal interest rate and credit markets necessary to use wholesale funding profitably, and ꧃the dangers that can result from changes in interest rates and a credit crunch.

What Is Wholesale Funding?

Wholesale funding refers to alternate funding sources for institutional borrowers. It is a catch-all term that mainly refers to 澳洲幸运5开奖号码历史查询:federal funds, 澳洲幸运5开奖号码历史查询:foreign deposits, and 澳洲幸运5开奖号码历史查询:brokered deposits. Some people also include borrowings in the public debt market in the wholesale funding definition.

Wholesale funding differs from the customary source of funding that, say, a 澳洲幸运5开奖号码历史查询:commercial bank uses. Tradit🦹ionally, banks use for funds due to their availability and ཧthe fact that they are an inexpensive source of financing.

Deposits represent a𝄹 liability for the b൲anks. Those deposits are lent out and become income-producing assets.

Reasons for Wholesale Funding

Financial institution𒐪s may turn to wholesale funding because:

• They need more funding to support their business activities, such as lending.
• They seek to diversify beyond bank deposits to avoid the risks of deposit withdrawals during times of economic volatility or crisis.
• Additional money from wholesale funding can help them manage liquidity risks.
• Quick access to extra funds can help them meet regulatory rules relating to capital reserves.
• Wholesale funding offers flexibility when managing lending risks.

Users of Wholesale Funding

Banks and𒀰 commercial finance companies are users of wholesaꦓle funding.

Such funding can be an alternative source of funds for banks, but commercꦯial finance companies especially rely on this kind of funding. 

Both of these types of financial institutions are regulated𓆉 differently and sometimes compete for the same business.

Commercial Finance Companies vs. Banks

Commercial fi🍌nance companies provide only business loans, as o🎃pposed to banks which provide both business and consumer loans.

Therefore, their primary customers are small- to mediu💖m-sized businesses that borrow to purchase inventory an💫d equipment.

Commercial finance companies also provide value-added services, such as consulting options and sales of 澳洲幸运5开奖号码历史查询:receivables.

They are not banks and can be🤪 a higher-cost borrowing choice for the small business owner. This is because they are less c🐽onservative than traditional banks and more willing to make riskier loans.

And as 💙they are not banks, they are s🅺ubject to less regulation and can assume more risk, which can be a double-edged sword in times of economic turbulence.

Forms of Wholesale Funding

If core deposits are such a cheap source of financing, why would anyone use wholesale funding🌳?

As noted above foꦛr banks, wholesale funding represents a way to expand or to satisfy funding needs. Furthermore, banks at times may have trouble attracting new deposits due to interest rates that are too low.

Wha🎃tever the reason, banks may look to wholesale funding. Such funding can take different🔯 forms, but a popular option for banks is brokered deposits.

Brokered Deposits

These deposits are made by a broker who takes their wealthy clients' money and finds several different banks in which to deposit it. This is usually done so that those clients receive FDIC insurance (and hopefully a more attractive rate of return).

If these wealthy clients deposited all of their money into one bank, it might exceed FDIC insurance limits. So brokers break up their cash holdings among different banks so that all of their deposits are insured against a bank failure.

Public Debt Markets

Commercial finance companies don't have the depositor base from which to draw funds. Therefore, they need to tap the public debt markets to 澳洲幸运5开奖号码历史查询:capitalize𒁏 themselves. ཧThen, these funds are lent out to small business clients at a higher rate.

Looking at this business model, it becomes apparent that it's important for a commercial finance company to have the highest 澳洲幸运5开奖号码历史查询:credit rating possible, so it can i🎀ssue debt at the lowest coupon rate possible.

How Wholesale Funding Can Be Profitable

A positive spread between rates for borrowing fu♐nds and rates for lending them out is needed in order for wholesale funding to work and be profitable.

A commercial finance company may experience 澳洲幸运5开奖号码历史查询:liquidity problems when sources of wholesale funding dry up, or the borrowing terms may become so onerous they are not profitable.

Your 澳洲幸运5开奖号码历史查询:cost of funds 🃏should be lower than the yield you earn on your assets (loans). Any other sce😼nario is unprofitable and not sustainable.

To achieve a positive spread, it is first necessary to have an upward slopi🍎ng yield curve, on which yields run from low to hig☂h, short-term to long-term.

An 澳洲幸运5开奖号码历史查询:inverted yield curve—one on wh🦄ich short-term rates are higher than long-term rates—means a company borrows at a higher rate than it earns. That's a negative spread. This is not profitable and leads to problems for banks and commercial f𓆉inance companies.

A 澳洲幸运5开奖号码历史查询:flat yield curve is also a problem because, again, it does not allow for the afor꧋ementioned positive spread scenario.

As the shape of the yield curve changes during the full business cycle, one can see the tangible impacts on 澳洲幸运5开奖号码历史查询:net income for banks and finance companies.

When the yield curve is upward sloping, ba🀅nk and commercial finance profitability is good. When it is inverted, profitability suffers. When it is in between or flattening, profitability is muted for banks.

For commercial finance companies, a flat yield curve can be unprofitable, because their source of funding is not the low-cost demand deposits that banks have access to, but higher cost sources of borrowed funds such as those from the 澳洲幸运5开奖号码历史查询:unsecured debt markets.

How Wholesale Funding Can Go Wrong

Under the right conditions, wholesale funding provides banks and finance companies additional sources of financing for operations and investment opporౠt﷽unities.

Commercial finance companies can be profitable for many years and through several 澳洲幸运5开奖号码历史查询:business cycles using wholesale funding.

But what happens when there is a 澳洲幸运5开奖号码历史查询:credit crunch, and the debt markets essentially shut-down? Or when short-term borrowing rates (as represented by a benchmark such as the fed funds rate or SOFR) soar due to financial uncertainty?

Each ཧsituation is troublesome. Both create a toxic combination that can bring a commercial finance company to the brink of bankruptcy and cause problems for banks.

If an institution's wholesale funding slows or ends, it could face liquidity problems. Short-term creditors could refuse to extend its debt. It might be forced to liquidate assets.

Dependin✤g on how interest rates fluctuate, these borrowers may find themselves paying more for their short-term funding than they earn on the🐲ir lending.

The funding spigot can turn off quickly if an๊ institution is perceived to be a credit risk. That can bꦦe a severe problem when it needs that funding for its ongoing operations and financial management.

Bank regulators can also prohibit brokered deposits if a bank is 澳洲幸运5开奖号码历史查询:undercapitalized. A bank in this situation is teetering꧂ on the edge.

The Bottom Line

Wholesale funding is useful for banks and finance companies that seek soꦯurces of funds beyond those they traditionally turn to.

However, wholesale funding has its risks. Banks can face severe liquidity🌱 risks if short-term funding dries up. They may be forced to 🍨sell assets.

Finance companies seen as deteriorating and risky will have to pa𒁏y more for funding, and this will📖 squeeze margins.

If an 澳洲幸运5开奖号码历史查询:economic tsunami hits and skyrocketing short-term rates and a credit🌸 crunch last for an extended period of time, banks and finance companies may suffer greatly and even face the prospect of bankruptcy.