01 February 2016

ECB: Recent developments in the composition and cost of bank funding in the euro area

This article gives an overview of recent developments in the composition and cost of bank funding, including capital, and shows that they varied across the euro area over the period of the financial crisis, which had an impact on the transmission of monetary policy.

Changes in the composition and cost of bank funding and capital have important implications for credit provision and, consequently, for output and inflation.  Banks’ funding costs are affected by monetary policy, but the transmission of monetary policy depends on many factors, including the strength of banks’ balance sheets and the macroeconomic environment.

Over the crisis, funding conditions fluctuated greatly, owing to changes in the economic environment, financial and sovereign market tensions and the monetary policy response to these developments. Bank funding structures changed considerably, in part reflecting the need to increase the weight of capital in the overall funding mix and reduce the overreliance on wholesale funding that was observed in the run-up to the crisis. The European Central Bank’s (ECB) standard and non-standard monetary policy measures provided considerable support to the economy over the different phases of the crisis. The Governing Council decreased the interest rate on refinancing operations and increased the quantity and maturity of liquidity provided to banks, which helped prevent disorderly deleveraging and mitigate the stress in funding markets. Steps towards a banking union and a more comprehensive regulatory environment have also encouraged a move towards a more sustainable and resilient funding structure. More recently, as the banking system has stabilised, policies have been introduced to address below-target inflation. The credit easing package introduced in the middle of 2014 and the APP provide additional liquidity and reduce funding costs, supporting banks’ intermediation capacity and, ultimately, output and inflation.

While monetary policy measures have helped to reduce the heterogeneity in euro area funding conditions (particularly for deposits and bonds, leading to improved policy transmission), there remain differences across countries, as seen in the cost of equity. The differences in the cost of equity across countries reflect remaining differences in perceived risk, as well as underlying differences in strength of banks’ balance sheets and expected profitability. Many of the problems for banks are related to structural issues that are outside the realm of monetary policy and require action from the private sector or governments to ensure a sustained recovery.

Current monetary policy measures and a changing regulatory environment will continue to affect the composition and cost of bank funding. Steps towards banking union and important regulatory initiatives at the global and European level will strengthen banks, which will have a considerable impact on their funding structure. While the adjustment to this new environment may carry costs in the short term, the reduction in the risk of further systemic crises will lead to a more stable banking system and robust transmission mechanism.

Full article

© ECB - European Central Bank