Working Paper

Arbitrage Capital of Global Banks

Abstract: We show that the role of unsecured, short-term wholesale funding for global banks has changed significantly in the post-financial-crisis regulatory environment. Global banks mainly use such funding to finance liquid, near risk-free arbitrage positions---in particular, the interest on excess reserves arbitrage and the covered interest rate parity arbitrage. In this environment, we examine the response of global banks to a large negative wholesale funding shock as a result of the U.S. money market mutual fund reform implemented in 2016. In contrast to past episodes of wholesale funding dry-ups, we find that the primary response of global banks to the reform was a cutback in arbitrage positions that relied on unsecured funding, rather than a reduction in loan provision.

Keywords: Money market mutual funds; Wholesale funding; Arbitrage;

JEL Classification: G20; F30; E40;

https://doi.org/10.17016/FEDS.2021.032

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2021-05-14

Number: 2021-032