No more level playing field as the cost of bank funding goes up

Banks must come to terms with higher costs of funding, putting some at a competitive disadvantage to their peers for the first time. The worst hit might have to rethink completely how they fund themselves.

The table shows where selected wholesale and investment banks’ five-year credit default swaps traded at the start of 2007, when just 15 basis points was the spread between what investors demanded on exposure to the least risky and the most risky. At the end of 2007, the cost of funding implied by CDS was much more widely dispersed, with some 135bp between the tightest level in our sample, for BNP Paribas, and the widest, for Bear Stearns.

For years, banks and trading firms had no problem expanding their balance sheets and trading books as low-cost interbank liquidity was abundant and the securitization markets grew.

European structured credit-funded issuance increased from less than €50 billion in 1998 to more than €450 billion for 2006. So analysts at Merrill Lynch point out that by the middle of last year, large European banks were operating with an average loans to deposits ratio of 130%. With €9.7 trillion of customer loans partly funded by €8.3 billion of deposits, that leaves European banks with an €1.4 trillion funding gap. The cost over the risk-free rate of filling that gap is going up.