Funding is the lifeblood for any leveraged institution. If the funding structure changes, so does the balance sheet composition and the fundamental profitability of the bank. With a sufficiently large outflow of funding, even the existence of a bank is at stake.

In the flurry of emergency measures issued by central banks during the 2008 financial crisis, banks were provided essentially costless liquidity. Policy normalization is likely to reverse this as other funding markets open up again. Furthermore, considering delayed investment decisions by individuals, precautionary saving and a search for as safe and liquid an asset as possible, bank deposits might not remain as stable as they seem to be now. Therefore, treasurers face two challenges: market-based credit intermediation (also known as wholesale funding) and retail funding.

Future funding structure

Treasurers have to think about the bank’s future funding structure. With liquidity levels already bloated, they may not have the leeway to let a few deals or a few depositors run away. They could start tapping the market again, but if rates go up, they start suffering.

Derivatives may help. Crucially, though, this relies on the willingness of the market to buy unsecured debt of banks. Particularly in Europe, where banks have historically played a strong role in the intermediation of credit between the market and individual firms, this can become quite a challenge.

An alternative solution is a revival of securitization practices. Well-regulated securitizations – those where the bank has “skin in the game” – are an alternative to issuing unsecured bonds and could be an important instrument to make the European banking sector more flexible. Although reviled in the immediate aftermath of the financial crisis, primarily for the alphabet soup of re-securitizations and the lack of transparency that went with it, these established “technologies” can help make banks’ funding more secure. In a world where investors have to closely look at the downside of investing in rates products, they also help tailor exposures to the specific credit risk appetites of the former.

The same idea – packaging of exposures – should hold true for retail funding. While praised by regulators and politicians as the foundation on which banks should do business, the ubiquitous disclaimer applies: past performance is no guarantee for future performance. For example, many banks see their balance sheets awash with retail deposits as a consequence of the financial crisis. However, it is not clear whether this will hold true going forward.

In addition, aside from the trend of precautionary saving and a lack of investment alternatives, tax considerations and fears of expropriation need to be taken into account. From an income tax perspective, the holes in the public coffers are worrying and could very well lead to tax increases. Structuring investment products for potentially tax-free outperformance over a normal savings deposit, while retaining the funding for the bank, can become a key driver. Furthermore, delaying taxation can help clients to distribute their tax burden across time periods. Of course, this depends on the general tax treatment of the respective jurisdiction. It also needs analysis from a cost-of-funds perspective.

Expropriation can be another driver. Direct expropriation – or financial repression – is sometimes touted as a panacea against the fallout of the financial crisis. While financial products cannot mitigate this risk, they can at least offer insulation from the negative effects of inflation or rate caps, both of which serve as an indirect means of taking away depositors’ money. Investment products that mimic the performance of say, equities, allow the bank to retain the mainstay of the funding previously provided by the deposits and therefore insulate itself and its clients from the shock.

Securitization can serve to transform both the business model and the balance sheet. On the retail side, by offering structured products that comprise a bond part coupled to an option, banks have another tried and tested instrument at hand to serve their clients.

The role of the treasury

Taking into account all the different types of exposures and risks around which to structure investment products requires the close involvement of the treasury. In smaller banks, treasury is the sole center of excellence around all rates products. But taking into account the maturities provided to clients and the potential impact of changing the funding structure may require corrective action, such as adjusting the hedging strategy of the banking book.

What if people are happy with savings deposits despite these trends? If sufficiently cheap, that outcome is not too bad. From a treasury perspective, banks must make sure that these deposits do not cost too much in margin. Alternatively, liquidity would be helpful. Either way, the treasury needs to ensure a fair burden sharing from a cost of funds perspective as well as devise product features from a liquidity perspective.