Funding Frictions after the Global Financial Crisis

Introduction

Funding frictions are tensions in financial markets that can preclude institutions from borrowing money or rolling over debt. In extreme situations, such as the 2007-2009 global financial crisis (GFC) or the market turmoil in March 2020 during the Covid-19 pandemic, funding frictions can lead to the default of otherwise healthy institutions and destabilize the entire financial system.

Importance of Understanding Funding Frictions

While earlier research (pre-GFC) tends to disregard funding frictions, the enormous risk associated with these market tensions highlights that a deeper understanding of funding frictions is crucial. It can guide policymakers to determine their optimal responses to future crises and help institutions reduce their funding risk.

Project Overview

In this project, I will investigate how funding frictions affect financing conditions for:

1. Countries
2. Banks
3. Pension plans
4. Life insurance companies

Manifestation of Funding Frictions

While funding frictions can, in the most extreme cases, lead to the bankruptcy of otherwise healthy entities, they usually first manifest through:

• Elevated costs for external financing
• Shorter debt maturities
• A lack of access to certain credit markets

Research Question

Focusing on these aspects, I will investigate the following question:

How did the market developments since the GFC affect funding frictions for countries, banks, pension funds, and insurance companies?

Post-Crisis Changes in Financial Markets

More specifically, I examine four post-crisis changes in financial markets:

1. Ballooning deficits in most developed economies
2. Tighter regulation of Money Market Mutual funds
3. Pension risk transfers with firms transferring their defined benefit (DB) pension plans to life insurance companies
4. Tighter bank regulation (as implemented in the Basel III capital accords)

I will study their impact on funding costs and access to credit markets.

Expected Outcomes

The results can help sovereigns manage their increasing debt levels and inform policymakers about the potentially unintended consequences of regulatory changes.