Short Term Funding Alternatives Available To Banks

Customer deposits (retail deposits) are a short-term funding source for banks. Checking accounts provide transactions services and immediate availability of funds but typically pay no interest. Money market mutual funds and savings accounts provide less liquidity or less transactions services, or both, and pay periodic interest.

In addition to funds from retail accounts, banks offer interest-bearing certificates of deposit (CDs) that mature on specific dates and are offered in a range of short-term maturities. Nonnegotiable CDs cannot be sold and withdrawal of funds often incurs a significant penalty.

Negotiable certificates of deposit can be sold. At the wholesale level, large denomination (typically more than $1 million) negotiable CDs are an important funding source for banks. They typically have maturities of one year or less and are traded in domestic bond markets as well as in the eurobond market.

Another source of short-term funding for banks is to borrow excess reserves from other banks in the central bank funds market. Banks in most countries must maintain a portion of their funds as reserves on deposit with the central bank. At any point in time, some banks may have more than the required amount of reserves on deposit, while others require more reserve deposits. In the market for central bank funds, banks with excess reserves lend them to other banks for periods of one day (overnight funds) and for longer periods up to a year (term funds). Central bank funds rates refer to rates for these transactions, which are strongly influenced by the effect of the central bank’s open market operations on the money supply and availability of short-term funds.

In the United States, the central bank funds rate is called the Fed funds rate and this rate influences the interest rates of many short-term debt securities.

Other than reserves on deposit with the central bank, funds that are loaned by one bank to another are referred to as interbank funds. Interbank funds are loaned between banks for periods of one day to a year. These loans are unsecured and, as with many debt markets, liquidity may decrease severely during times of systemic financial distress.