Banks ‘over reliant on wholesale funding’

TOO many banks were over reliant on wholesale funding when the credit crunch blew up last August, causing a massive liquidity crisis in the global banking sector.

“The question is how wise is it to have a funding strategy that is 100% based on wholesale funding,” said Mario Draghi, governor of the Bank of Italy, who addressed the banking community in Dublin yesterday.

Responding to a question after he delivered the Central Bank Whitaker lecture in Dublin Castle, Mr Draghi said banks that relied solely on the inter-bank markets for their funding were the ones who suffered most.

“Banks who had a diversified financial strategy were the ones who coped best”, he said.

Financial institutions also failed to “pay enough attention to the Central Banks at certain times” as the build up to the credit crunch unfolded in the preceding years.

At least “two and a half years ago he was aware of what was building up” in relation to the credit situation, he said. Banks had been offering “perverse incentives” to borrowers that eventually led to loss of confidence.

Lack of liquidity was the key problem in many cases, rather than systemic problems among the banks, he said. Central banks were pretty effective in dealing with the liquidity crisis, though in future it was clear they would have to cooperate more fully to prevent a recurrence of the current crisis.

Asked about how long this current crisis will last, he said: “I have an extraordinary admiration for those people who say the financial crisis is behind us, or the financial crisis will last for another three years, or it will become much worse than it is today, or we haven’t seen any crisis like this today. It’s very hard to say”.

“It is our communication that will induce either stigma or trust”, he said. Even well intentioned announcements can trigger “herd behaviour and exacerbate liquidity problems” the events of the last year demonstrated.