The Golden Rule of Banking: Funding Cost Risks of Bank Business Models

Abstract

The liquidity regulation of banks in Pillar 1 of the Basel framework does not consider funding cost risks of different bank business models. Therefore, we assemble a data set of balance sheet positions including maturities and use the method of Value-Liquidity-at-Risk to explore 118 European retail, wholesale, and trading banks. When examining liquidity-induced equity risks, triggered by exemplary rating shifts, we find that retail banks bear significantly lower funding cost risks than wholesale and trading banks. Consequently, a prudential regulation, which simultaneously considers the funding cost risk and the diversification of the banking system is recommended.

Keywords: Bank Business Models, Funding Cost Risk, Liquidity Requirements, Value-Liquidity-at-Risk, Value Liquidity Expected Shortfall

JEL Classification: G21, G28