Last updated: 28 February 2017
At a glance
- The funding of lenders consists of two important elements: liquidity to provide loans (mortgages, personal loans etc.) and capital to absorb losses.
- It is important for lenders to have a broad funding base, with the widest access to both liquidity and capital. Lenders look to diversify their funding bases to avoid reliance on one form of funding - diversification can include different investor bases, a variety of currencies and different maturities.
- Larger lenders raise funding from the retail market (depositors), but will also access the wholesale markets. This can be in the form of loans from other financial institutions, or by issuing securities (bonds or shares) which are then bought by, mostly, institutional investors. Generally, to access the wholesale capital markets, a lender will need a credit rating that helps investors assess the risk of the individual security and the lender. Types of wholesale securities include senior, unsecured bonds, covered bonds and securitisations. (Both covered bonds and securitisations benefit from a pool of collateral, often mortgages, to improve the credit worthiness and provide cash flow to repay the security).
- Smaller lenders raise the majority of their funding from depositors, via current and savings accounts.
- During 2016, the Bank of England introduced a new funding scheme for mortgage lenders called The Term Funding Lending Scheme. We welcome the Bank's involvement in providing an alternative source of funding in addition to the wholesale capital markets and deposit markets.
- For all lenders it is important to have as diversified funding base as possible. This means raising funds from different types of investors, at different maturities and if possible in different currencies. The advantage of a diversified funding base is that it allows lenders to manage their liquidity if there is a shock to a specific market that prevent lenders from raising funds from that particular market.
- Regulators have strengthened the requirements of lenders to hold liquidity. As part of CRD/CRR IV, the EU introduced a Liquidity Coverage Ratio (LCR). The Bank of England (The Bank) published a consultation paper (CP27/14) on transposing this regulation into the UK regulatory regime that closed on 27 February 2015.
- UK liquidity regulation is part of the sterling monetary framework (SMF). Within the SMF, the Bank of England has a number of tools or facilities lenders can access to address liquidity issues. Lenders have accessed a variety of these facilities; and, where appropriate, also access EU liquidity facilities.
We support the strengthening of the regulatory architecture of the UK financial system in so far as it creates a more robust and stable system. We do not favour one form of funding over another, but support initiatives that enable members to diversify their funding bases.
Existing regulation, for example Solvency II and the proposed LCR, continue to differentiate in favour of covered bonds over residential mortgage backed securities (RMBS). Given the robustness of the UK RMBS structure and the asset quality underpinning UK RMBS, we continue to campaign for these product to be treated equally in the UK.
Why this is important for lenders
Following the financial crisis 2008-2012, various countries, including the UK, have introduced additional regulatory oversight of the financial system as a whole. One of the factors identified as contributing to the crisis, was the lack of liquidity held by lenders to cover short-term market and lender specific issues.
Regulation is therefore focused on lenders have more liquidity to cover these shocks, but also a better quality of liquidity i.e. assets that can be converted to cash even in adverse market conditions. In addition, lenders need to have a better mixed of assets and liabilities to avoid a short term liquidity crisis.