The macroeconomic effects of a stable funding requirement
This paper examines the macroeconomic effects of a bank stable funding requirement of the type proposed under Basel III and introduced in New Zealand in 2010. The paper sets out a small open economy model incorporating a banking sector funded by retail deposits and short- and long-term wholesale borrowing, with a tractable setup for multi-period debt that allows hedging of benchmark interest rate risk. A stable funding requirement increases rollover in long-term funding markets, despite lower aggregate rollover. Greater exposure to long-term funding markets attenuates credit expansion if funding costs rise more steeply with volumes in less-liquid long-term markets. However, it amplifies the pro-cyclical effects of fluctuations in funding spreads because variations in long-term spreads are larger and are carried for the duration of the funding (cannot be hedged). Such amplification increases in the level of the requirement and the level of net debt. We explore approaches to moderating adverse macroeconomic outcomes.